Stockholders' Equity

What Is Stockholders' Equity?

Stockholders' equity, also referred to as shareholders' or owners' equity, is the remaining amount of assets available to shareholders after all liabilities have been paid. It is calculated either as a firm's total assets less its total liabilities or alternatively as the sum of share capital and retained earnings less treasury shares. Stockholders' equity might include common stock, paid-in capital, retained earnings, and treasury stock.

Conceptually, stockholders' equity is useful as a means of judging the funds retained within a business. If this figure is negative, it may indicate an oncoming bankruptcy for that business, particularly if there exists a large debt liability as well.

Understanding Stockholders' Equity

Stockholders' equity is often referred to as the book value of the company and it comes from two main sources. The first source is the money originally and subsequently invested in the company through share offerings. The second source consists of the retained earnings (RE) the company accumulates over time through its operations. In most cases, especially when dealing with companies that have been in business for many years, retained earnings is the largest component.

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.

Equity, also referred to as stockholders' or shareholders' equity, is the corporation's owners' residual claim on assets after debts have been paid.

How to Calculate Stockholders' Equity

The formula for calculating stockholders' equity is:

Stockholder’s Equity = Total Assets − Total Liabilities \text{Stockholder's Equity} = \text{Total Assets} - \text{Total Liabilities} Stockholder’s Equity=Total Assets−Total Liabilities

Finding the Relevant Data

All the information required to compute shareholders' equity is available on a company's 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). 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, shareholders' equity can be determined.

Example of Stockholders' Equity

Below is the balance sheet for Apple Inc. (AAPL) as of September 2020. For that period:

Apple Balance Sheet.

Stockholders' equity was therefore $65.339 billion ($323.888 - $258.549).

Looking at the same period one year earlier, we can see that the year-on-year change in equity was a decrease of $25.15 billion. The balance sheet shows this decrease is due to both a reduction in assets and an increase in total liabilities.

The value of $65.339 billion in shareholders' equity represents the amount left for stockholders if Apple liquidated all of its assets and paid off all of its liabilities.

An alternative calculation of company equity is the value of share capital and retained earnings less the value of treasury shares.

Stockholders' equity is an effective metric for determining the net worth of a company, but it should be used in tandem with analysis of all financial statements, including the balance sheet, income statement, and cash flow statement.

Paid-In Capital and Stockholders' Equity

Companies fund their capital purchases with equity and borrowed capital. The equity capital/stockholders' equity can also be viewed as a company's net assets (total assets minus total liabilities). Investors contribute their share of (paid-in) capital as stockholders, which is the basic source of total stockholders' equity. The amount of paid-in capital from an investor is a factor in determining his/her ownership percentage.

Retained Earnings Role in Creating Greater Stockholders' Equity

Retained earnings (RE) are a company's net income from operations and other business activities retained by the company as additional equity capital. Retained earnings are thus a part of stockholders' equity. They represent returns on total stockholders' equity reinvested back into the company.

Retained earnings accumulate and grow larger over time. At some point, accumulated retained earnings may exceed the amount of contributed equity capital and can eventually grow to be the main source of stockholders' equity.

Treasury Shares' Impact on Stockholders' Equity

Companies may return a portion of stockholders' equity back to stockholders when unable to adequately allocate equity capital in ways that produce desired profits. This reverse capital exchange between a company and its stockholders is known as share buybacks. Shares bought back by companies become treasury shares, and their dollar value is noted in the treasury stock contra account.

Treasury shares continue to count as issued shares, but they are not considered to be outstanding and are thus not included in dividends or the calculation of earnings per share (EPS). Treasury shares can always be reissued back to stockholders for purchase when companies need to raise more capital. If a company doesn't wish to hang on to the shares for future financing, it can choose to retire the shares.

Stockholders' Equity FAQs

What Is Included in Stockholders' Equity?

Total equity effectively represents how much a company would have left over in assets if the company went out of business immediately

What Are Some Examples of Stockholders' Equity?

Every company has an equity position based on the difference between the value of its assets and its liabilities. Positive equity indicates the company has a positive worth. A company's share price is often considered to be a representation of a firm's equity position.

How Do You Calculate Equity?

Stockholders' equity is equal to a firm's total assets minus its total liabilities. These figures can all be found on a company's balance sheet.

 Is Stockholders’ Equity Equal to Cash on Hand?

No. Since equity accounts for total assets and total liabilities, cash and cash equivalents would only represent a small piece of a company's financial picture.