What is 'Stockholders' Equity'
Stockholders' equity is the portion of the balance sheet that represents the capital received from investors in exchange for stock (paid-in capital), donated capital and retained earnings. Stockholders' equity represents the equity stake currently held on the books by a firm's equity investors. It is calculated either as a firm's total assets minus its total liabilities or as share capital plus retained earnings minus treasury shares.
BREAKING DOWN 'Stockholders' Equity'Stockholders' equity is often referred to as the book value of the company, and it comes from two main sources. The first and original source is the money that was originally invested in the company, along with any additional investments made thereafter. The second comes from retained earnings that the company is able to accumulate over time through its operations. In most cases, especially when dealing with older companies that have been in business for many years, the retained earnings portion is the largest component.
Companies fund their asset purchases with equity capital, namely stockholders' equity, and borrowed capital from issuing debt and incurring other liabilities. The equity capital or stockholders' equity can also be viewed as a company's net assets — that is, total assets minus total liabilities, the amount of monetary interest that belong to the company's owners or stockholders. Investors originally and maybe later again contribute their share of capital as stockholders, and the capital so contributed is called paid-in capital, which is the basic source of total stockholders' equity. The amount of paid-in capital from each investor determines an investor's stockholder ownership percentage.
Retained earnings are a company's net income from operations and other business activities, available to stockholders and retained by the company as additional equity capital. Retained earnings are thus part of stockholders' equity. They are actually returns on total stockholders' equity but reinvested back to the company. Retained earnings are accumulated and grow larger over time as a company retains a portion of its earnings after dividends each year. At some point, the amount of accumulated retained earnings is to exceed the amount of equity capital contributed by stockholders and can eventually grow to be the main source of stockholders' equity.
Companies may return some capital out of its stockholders' equity back to stockholders from time to time when management is not able to deploy all the available equity capital in ways that can potentially deliver the best returns. 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 an account called treasury stock, a contra account to the accounts of paid-in capital and retained earnings. Treasury shares can be reissued back to stockholders for purchases when companies need to raise more capital.