What is 'Shareholders' Equity'
Shareholders' equity is equal to a firm's total assets minus its total liabilities and is one of the most common financial metrics employed by analysts to determine the financial health of a company. Shareholders' equity represents the net value of a company, or the amount that would be returned to shareholders if all the company's assets were liquidated and all its debts repaid.
BREAKING DOWN 'Shareholders' Equity'
Shareholders' equity is also known as net worth or stockholders' equity.
Shareholders' equity can be either negative or positive. If the figure is positive, it means the company has more than enough asset value to cover its liabilities. If the figure is negative, the company has debts that outweigh its assets. In general, a company with negative shareholders' equity is not considered a safe investment choice, because either its asset total is too low or its liability total is too high. In either case, the company has more debt than its current assets can possibly satisfy, putting it at risk of loan default and bankruptcy.
Computing Shareholders' Equity
All the information needed to compute a company's shareholders' equity is available on its balance sheet. The shareholders' equity equation requires that you find a company's total assets and total liabilities. This means including both short-term assets and long-term assets. The short-term assets include things such as retained earnings, share capital and other cash assets held in banking and savings accounts, stocks, bonds and money market accounts. Long-term assets include things such as equipment, property, illiquid investments and vehicles. Short-term liabilities include any payments and interest due on loans within the current year, accounts payable, wages, operating costs and insurance premiums. Long-term liabilities include any and all debts owed that are not due within the current year, such as mortgages, loan balances and payments to bondholders. Once the short- and long-term figures are added, computing shareholders' equity is simply a matter of subtraction.
Assume company ABC's balance sheet shows $600,000 in retained earnings held in cash, $500,000 in stocks, and $1.5 million in equipment and other fixed assets. It also shows the following debts or expenses to be paid: $800,000 in loans and mortgages, $100,000 in wages, $10,000 in insurance premiums, and accounts payable totaling $10,000. According to the balance sheet, ABC has $2.6 million in total assets and $920,000 in total liabilities. After subtracting the liabilities from the assets, ABC's shareholders' equity is $1.68 million.
Shareholders' equity can also be expressed as a company's share capital plus retained earnings, minus the value of treasury shares. This method, however, is less common. Though both methods should yield the same figure, the use of total assets and total liabilities is more illustrative of a company's financial health. By comparing concrete numbers reflecting everything the company owns and everything it owes, this "assets-less-liabilities" shareholders' equity equation paints a clear picture of a company's finances that is easily interpreted by laymen and professionals alike.