What does negative shareholder equity on a balance sheet mean?

By Ken Clark AAA
A:

N

egative shareholder equity could show up on a company's balance sheet for a number of reasons, all of which should serve as red flags to look much closer before investing. To understand why, you need to look no further than the formula for shareholder equity:

Total Assets - Total Liabilities = Shareholder Equity

As a measure, shareholder equity reveals what the owners of a company (stockholders) would be left with if all assets were sold and all debts were paid. In the case of negative shareholder equity, the owners theoretically would owe money, although the structure of publicly traded corporations prevents common stockholders from facing actual liability.

Negative shareholder equity most often comes from the accounting methods used to deal with accumulated losses from prior years. These losses generally are viewed as liabilities carried forward until future cancellation. Oftentimes, the losses exist on paper only, which makes it possible for a company to maintain operations, despite the continued posting of substantial losses.

Other situations that can contribute to negative shareholder equity are leveraged buyouts (or borrowing), severe depreciation in currency positions and substantial adjustments to intangible property (patents, copyrights, goodwill and the like).

For more on this topic, read Breaking Down the Balance Sheet.

This question was answered by Ken Clark.

RELATED FAQS

  1. What's the difference between economic value added (EVA) and accounting profit?

    Learn the differences between economic value added and accounting profit. Understand the numbers used in each calculation ...
  2. What are some examples of fixed assets?

    Learn the difference between fixed tangible assets and fixed intangible assets, and review examples of these two types of ...
  3. Why would I need total debt to total assets represented as a ratio, as opposed to ...

    Learn why having the relationship between a company's total debt and its total assets is more valuable when expressed as ...
  4. Is a deficit in the balance of payments a bad thing?

    Discover how it might be possible to run a balance of payments deficit, what that means in terms of international trade and ...
RELATED TERMS
  1. Convention Statement

    A document filed by an insurance or reinsurance company that ...
  2. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company ...
  3. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative ...
  4. Nonadmitted Balance

    An item on an insurer’s balance sheet that represents reinsured ...
  5. Earned Premium

    The amount of total premiums collected by an insurance company ...
  6. Best's Capital Adequacy Relativity (BCAR)

    A rating of an insurance company’s balance sheet strength. Best’s ...

You May Also Like

Related Articles
  1. Stock Analysis

    Freeport-McMoRan Is Seeking A Helping ...

  2. Stock Analysis

    Chesapeake Energy Sees History Repeating ...

  3. Stock Analysis

    Is Prospect Capital Exposed To Elevated ...

  4. Mutual Funds & ETFs

    Buying ETFs on Margin Versus Leveraged ...

  5. Investing

    Ready To Invest In Financial Leverage ...

Trading Center