Shareholder Equity-Meaning,Understanding,Components of Shareholder Equity,Calculation (Commerce Achiever)

For corporations, shareholder equity (SE), also referred to as stockholders’ equity, is the corporation’s owners’ residual claim on assets after debts have been paid. Shareholder equity is equal to a firm’s total assets minus its total liabilities.

Understanding Shareholder Equity (SE)

Retained earnings is part of shareholder equity and is the percentage of net earnings that were not paid to shareholders as dividends. Retained earnings should not be confused with cash or other liquid assets. This is because years of retained earnings could be used for either expenses or any asset type to grow the business. Shareholders’ equity for a company that is a going concern is not the same as liquidation value. In liquidation, physical asset values have been reduced and other extraordinary conditions exist.

Shareholder equity can be either negative or positive. If positive, the company has enough assets to cover its liabilities. If negative, the company’s liabilities exceed its assets. If prolonged, this is considered balance sheet insolvency.

For this reason, many investors view companies with negative shareholder equity as risky or unsafe investments. Shareholder equity alone is not a definitive indicator of a company’s financial health. If used in conjunction with other tools and metrics, the investor can accurately analyze the health of an organization.

All the information needed to compute a company’s shareholder equity is available on its balance sheet. Total assets include current and non-current assets. Current assets are assets that can be converted to cash within a year (e.g., cash, accounts receivable, inventory, et al.). Long-term assets are assets that cannot be converted to cash or consumed within a year (e.g. investments; property, plant, and equipment; and intangibles, such as patents).

Total liabilities consist of current and long-term liabilities. Current liabilities are debts typically due for repayment within one year (e.g. accounts payable and taxes payable). Long-term liabilities are obligations that are due for repayment in periods longer than one year (e.g., bonds payable, leases, and pension obligations). Upon calculating the total assets and liabilities, shareholder equity can be determined.

Shareholder equity is an important metric in determining the return being generated versus the total amount invested by equity investors. For example, ratios like return on equity (ROE), which is the result of a company’s net income divided by shareholder equity, is used to measure how well a company’s management is using its equity from investors to generate profit.

For example, assume that ABC company has total assets of $2.6 million and total liabilities of $920,000. Therefore, ABC shareholder equity is $1.68 million.

As a real-world example, Pepsi Co Inc.’s (NYSE: PEP) total stockholders’ equity declined in the two year period from $17.4 billion in 2014 to $11.1 billion in 2016, which—depending on the reasons—might give analysts concern for the soda and snack food giant’s health.1 In the same period, arch-rival Coca-Cola Corporation’s (NYSE: KO) total shareholder equity fell from $30.3 billion to $23.01 billion.2 But the percentage drop isn’t as great because Coke’s liabilities and accounts payable also consistently decreased, while Pepsi’s increased, suggesting Coke had a better handle on its debt.

Shareholder Equity Calculation

​Shareholders’ equity=total assets−total liabilities​

The formula above is also known as the accounting equation or balance sheet equation. The balance sheet holds the basis of the accounting equation.

The steps to calculate shareholder equity are as follows:

1. Locate the company’s total assets on the balance sheet for the period.
2. Total all liabilities, which should be a separate listing on the balance sheet.
3. Locate total shareholder’s equity and add the number to total liabilities.
4. Total assets will equal the sum of liabilities and total shareholder equity.

For some purposes, such as dividends and earnings per share, a more relevant measure is shares “issued and outstanding.” This measure excludes Treasury Shares (stock owned by the company itself).

What Can Shareholder Equity (SE) Tell You?

Shareholder equity is an important metric in determining the return being generated versus the total amount invested by equity investors. For example, ratios like return on equity (ROE), which is the result of a company’s net income divided by shareholder equity, is used to measure how well a company’s management is using its equity from investors to generate profit. If shareholder equity is positive that means the company has enough assets to cover its liabilities, but if it is negative, then the company’s liabilities exceed its assets, which is cause for concern. Essentially, it tells you the value of a business after investors and stockholders are paid out.

What Are the Components of Shareholder Equity (SE)?

Aside from stock (common, preferred, and treasury) components, the SE statement also includes sections that report retained earnings, unrealized gains and losses , and contributed (additional paid up) capital. The retained earnings portion reflects the percentage of net earnings that were not paid to shareholders as dividends and should not be confused with cash or other liquid assets.

How Is SE Calculated?

Shareholders’ equity is the difference between a firm’s total assets and total liabilities. This equation is known as a balance sheet equation as all the relevant information can be gleaned from the balance sheet. Take the equity at the onset of the accounting period, add or subtract any equity infusions (such as adding cash from shares issued or subtracting cash used for treasury purchases), add net income, subtract all cash dividends paid out and any net losses, and what you have left is the shareholder equity for that period.