How to Calculate Shareholders’ Equity (Plus Examples)
By Indeed Editorial Team
Published 29 June 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
There are many ways financial professionals can calculate a company's financial performance. One method is shareholders' equity, which helps to inform decisions regarding potential company investments and to determine a company's fiscal health. Learning more about what shareholder's equity is and how to calculate it can help you make better decisions about which companies are suitable for investment. In this article, we define what shareholders' equity is, explain how to calculate it and share some examples of different types of shareholders' equity.
What is shareholders' equity?
Shareholders' equity is a term used to refer to a company's financial net worth. The amount of equity often reflects how much money a company can return to its shareholders if it liquidates its assets and repays all its debts. You can usually find shareholder's equity on a business's balance sheet, as financial professionals often use this calculation to determine a company's financial health. You can also use shareholders' equity to calculate other value ratios to find out more about a company's fiscal health and determine investment suitability.
How to calculate shareholders' equity
To understand how to calculate shareholders' equity, you can subtract a company's total liabilities from its total assets. You can usually find this information on a company's balance sheet. A way to calculate the total assets is to subtract the value of treasury shares from a company's share capital and its retained earnings. The following steps give more detail on how to calculate shareholders' equity:
1. Find out the company's total assets
An asset refers to a resource that has an economic value that a company expects to produce benefits in the future. Companies report their assets on their balance sheets and expect them to reduce expenses, create more cash flow and improve sales margins. Some of these assets may include the following:
Current assets: Current assets refer to short-term economic sources that companies aim to convert into cash within a year. Current assets can include cash or cash equivalents, other liquid assets, marketable securities, supplies and inventory, accounts receivable and prepaid expenses.
Fixed assets: Fixed assets refer to long-term economic resources that usually take a set period to convert into cash. Some fixed-term assets include production plants, large equipment and facilities.
Financial assets: Financial assets are sources that have an economic value and derive from a contractual claim, even though they may not have a physical presence. Some of these assets may include copyright, trademarks, goodwill or patents.
2. Calculate the sum of the company's total liabilities
After identifying the total assets a company owns, you can then find out the sum of its total liabilities. Total liabilities refer to the obligations and debts that a company may owe to third parties. You can usually find these types of liabilities on a company's balance sheet. Some examples of company liabilities may include the following:
Short-term liabilities: Short-term liabilities refer to obligations and debts a company owes to outside parties that are due within a year or less. Some of these short-term liabilities may include rent, accounts payable or expenses from payroll.
Long-term liabilities: Long-term liabilities refer to financial obligations a company is due to pay after a year or more. They're also known as non-current liabilities and include duties like loans, tax obligations and pensions.
Other liabilities: Other liabilities refer to financial debts that don't usually fit under the other two categories above as they're less consequential. They can include liabilities like sales taxes or borrowing between companies.
3. Subtract the total assets from the total liabilities
After determining a company's total assets and total liabilities, you can calculate its shareholders' equity. Calculating this can help you understand more about a company's current financial standing and assist you in identifying any risks relating to the investment. When calculating shareholders' equity, you can use the following simple formula:
Shareholders' equity = Total assets − Total liabilities
What is the importance of understanding shareholders' equity?
Knowing how to calculate shareholders' equity is beneficial because it helps potential investors to better understand a company's financial health, helping them to make better decisions on investment matters. It can also enable a better understanding of how a company funds its projects and operations, whether it's through loans or getting funds from other means. When paired with other fiscal metrics, shareholder's equity can help you obtain a clearer outlook of a company's financial standing.
Depending on a company's debts and assets, its shareholders' equity may be positive or negative. When the equity is positive, it means that the company has enough assets to cover its liabilities. If the shareholders' equity is negative, it means that the assets a company can liquidate aren't enough to pay off its liabilities. Positive equity usually means that the company is financially healthy, and it may be safer to invest in. Negative equity or equal asset-to-debt ratio usually means that a company isn't as financially healthy, which means any investment in the business may be high risk.
What is the difference between a shareholder and an equity holder?
Knowing the differences between a shareholder and an equity holder can help you understand more about shareholders' equity. A shareholder refers to an individual that owns stock shares in an organisation but doesn't own the whole equity stake in it. An equity holder refers to one or more owners that possess the company's entire equity but don't hold any shares. One example of this is a sole proprietorship, where a company owner possesses all the equity or net worth of a single company.
Examples of shareholders' equity calculations
To help you understand more about shareholders' equity, the following are some examples of how to calculate it:
Explore this example on calculating shareholders' equity to determine the financial health of the company:
A company you're thinking of investing in reports $800,000 in total assets and $1.2 million in total liability. Using the shareholders' equity formula, subtracting the total liability of $1.2 million from the total assets of $800,000 gives a shareholders' equity of −$400,000. This means that the company has more debt than liquid capital at the present time, and it might be risky to invest in it. In this situation, it may be better to hold off on making any investments in the company or pass up the opportunity to invest altogether.
Here's another example detailing different types of liabilities:
A company that you own stocks in reports $3 million in current assets and $1.1 million in fixed assets. It also has long-term liabilities equalling $800,000 and short-term liabilities totalling $1.2 million. To determine the shareholders' equity, you can first find out the company's total assets, which is the sum total of its current assets and fixed assets, giving a figure of $4.1 million.
You can then find out its total liabilities by adding its long-term and short-term liabilities, resulting in $2 million. This gives a shareholders' equity of $2.1 million after subtracting the total liabilities of $2 million from the total assets of $4.1 million, which means that the company is still financially healthy.
Review this example to learn how to make sound investment decisions:
A company that you own stocks in reports $80,000 in current assets and $800,000 in fixed assets. It also reports a total liability of $880,000. To find out the shareholders' equity, you can find out the total assets, which are $880,000.
Using the equation, this gives a shareholders' equity of $0. A shareholders' equity of $0 means that the company's asset-to-debt ratio is equal, which suggests that the company may be in financial difficulties. Continuing to invest in the company may be a risky choice, so it's important to conduct more research into the business to determine if it's a good idea to continue investing or not.
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