Shareholders’ Equity: Meaning, Calculation, Components, and More

Looking to invest in a company’s stocks? Do not forget to check its balance sheet and shareholders’ equity since it reveals a lot. The shareholders’ equity can help you evaluate a company’s stability and long-term prospects before investing.

However, beginners do not know the shareholders’ equity meaning. If you are one of them, this blog provides a detailed guide on shareholders’ equity with an example.

What is Shareholders’ Equity?

The shareholders’ equity is a company’s net value, which is determined by the remaining assets that its shareholders may claim after all of its debt has been settled. You can calculate it by subtracting all of a company’s liabilities from all of its assets.

In this sense, shareholders’ equity also applies to a company’s retained earnings. They are reinvested to support the company’s expansion rather than being distributed as dividends to shareholders.

Shareholders’ equity is important for investors and analysts since it is a measure of a company’s capability to obtain capital, grow, and maintain financial stability. Changes in shareholders’ equity can impact both the value of a company’s shares and the amount of dividends paid to shareholders.

How to Calculate Shareholders’ Equity?

You can calculate a company’s shareholders’ equity using the formula:

Shareholders’ Equity = Total Assets – Total Liabilities

In this formula, total assets are a company’s resources, valuable things, and property that the company owns to yield future financial gains. On the other hand, total liabilities are a company’s outstanding debts to third parties that must be paid off in the future.

Example of Shareholders’ Equity

To understand the calculation of shareholders’ equity more clearly, let us use an example. For example, company X has total assets of INR 10,00,000 and total liabilities of INR 5,00,000. Then the shareholders’ equity of X is:

Shareholders’ Equity = INR (10,00,000 – 5,00,000) = INR 5,00,000

Components of Shareholders’ Equity

Below are the main components of shareholders’ equity:

• Outstanding Shares

Outstanding shares are the stocks that the company sells to the stockholders and does not repurchase. These shares are issued to public investors and company officers.

• Additional Paid-in Capital

The additional paid-in capital is an amount which is paid for shares that are higher than their stated par value. You can calculate the additional paid-in capital by deducting the par value of a single preference or common share from its selling value. Investors consider this component when they directly purchase shares from the company.

• Treasury Stock

Treasury stock is a group of outstanding shares that a company often buys back from its shareholders. They lower the shareholders’ equity and are subtracted from the share capital’s value while calculating shareholders’ equity.

• Retained Earnings

Retained earnings are an amount that is retained by a company’s management from its profit instead of paying out to its shareholders as a dividend. The management uses these earnings to pay off debts or reinvest in the operations.

You can find the retained earnings in a company’s balance sheet under shareholders’ equity, which also determines its retention ratio.

What Does Shareholders’ Equity Indicate?

The shareholders’ equity of a company indicates the company’s financial well-being. It can be either positive or negative. The positive shareholders’ equity indicates that a company has more assets than its liabilities, and a negative one signifies the opposite. If a negative shareholders’ equity remains for a longer period, it can lead to insolvency of the balance sheet.

A lot of investors hesitate to invest in companies with negative shareholders’ equity, since it is an unsafe or risky investment option for them. It is one of the most important metrics in determining your return on investment (ROI) on equities.

However, you should not only rely on shareholders’ equity, as it is not an absolute determinant for the same.

Final Thought

Shareholders’ equity can be an ideal metric for you if you want to invest in a company. It can help you make the right investment decisions. It also denotes how effectively a company is using its share capital to make returns.

If you want to invest in a company’s stock, you can download the PL Capital Group – Prabhudas Lilladher application. PL Capital allows you to invest in company stocks and mutual funds by offering a free Demat account opening facility.

Frequently Asked Questions

• What does shareholders’ equity mean?

Shareholders’ equity is a company’s profit, which represents the residual value belonging to owners after the payment of liabilities. It can be both positive and negative.

• How can we calculate shareholders’ equity?

You can calculate a company’s shareholders’ equity by subtracting the company’s total liabilities from its total assets.

• What makes up shareholders’ equity?

The primary components of shareholders’ equity are outstanding shares, retained earnings, treasury stocks, and additional paid-in capital.

• Is it bad when shareholders’ equity is negative?

A negative shareholders’ equity indicates that a company does not have enough assets to cover its liabilities and can face financial struggle over time.

• Can I call shareholders’ equity an asset?

No, shareholders’ equity is an obligation to the company’s shareholders and not an asset.

• How is book value related to shareholders’ equity?

Shareholders’ equity is a component which makes up a company’s book value. It represents the total value of a company’s assets, which you see in its balance sheet. You can calculate a book value by subtracting the total liabilities of a company from its total assets. However, the shareholders’ equity represents the assets owned by shareholders.

• Can the shareholders’ equity fluctuate over time?

Yes, shareholders’ equity can significantly fluctuate over time because of a wide variety of factors. These include the company’s financial performance, corporate actions, and market conditions.