Investors and corporate accounting professionals analyze shareholders' equity (SE) to determine how a company is using and managing initial investments and to determine company valuation. Shareholders' equity is calculated simply as total company assets minus total company liabilities. But there are several components that make up this equity calculation, which we'll review in this article.
- Shareholders' equity is the amount of money a company could return to shareholders if all its assets were converted to cash and all its debts were paid off.
- Four components that are included in the shareholders' equity calculation are outstanding shares, additional paid-in capital, retained earnings, and treasury stock.
- If shareholders' equity is positive, a company has enough assets to pay its liabilities; if it's negative, a company's liabilities surpass its assets.
- Shareholders' equity is a financial metric that helps investors evaluate the worth of a company and its long-term sustainability.
The number of outstanding shares is an integral part of shareholders' equity. It is the amount of company stock that has been sold to investors and not repurchased by the company. It represents the total amount of stock the company has issued to public investors, company officers, and company insiders, including restricted shares.
This figure includes the par value of common stock, as well as the par value of any preferred shares the company has sold. Outstanding shares are also an important component of other calculations, such as the calculations for market capitalization and earnings per share (EPS).
Additional Paid-in Capital
Shareholders' equity also includes the amount of money paid for shares of stock above the stated par value, known as additional paid-in capital (APIC). This figure is derived from the difference between the par value of common and preferred stock and the price each has sold for, as well as shares that were newly sold.
APIC only occurs when an investor buys shares directly from a company. It represents the additional amount an investor pays for a company's shares over the face value of the shares during a company's initial public offering (IPO). You can find the APIC figure in the equity section of a company's balance sheet.
When a company retains income instead of paying it out as a dividend to stockholders, a positive balance in the company’s retained earnings account is created. A company often uses retained earnings to pay off debt or reinvest in the business.
This figure is included in shareholders' equity and is typically the largest line item in this calculation. You can find a company's retained earnings on its balance sheet under shareholders' equity or in a separate statement of retained earnings. A company may refer to its retained earnings as its "retention ratio" or its "retained surplus."
The final item included in shareholders' equity is treasury stock, which is the number of shares that have been repurchased from investors by the company. A company will hold its own stock in its treasury for later use. It might sell the stock at a later date to raise capital or it might use it to prevent a hostile takeover.
Treasury stock reduces total shareholders' equity on a company's balance sheet. This figure is subtracted from a company's total equity, as it represents a smaller number of available shares for investors once it is repurchased.
A company lists its treasury stock as a negative number in the equity section of its balance sheet. Treasury stock can also be referred to as "treasury shares" or "reacquired stock."
The Bottom Line
Ultimately, shareholders' equity is used to evaluate the overall worth of a company. But numerous components of the balance sheet calculation are needed to gain deeper insight into a company's financial management. By calculating shareholders' equity, an investor can determine if a company has enough assets to cover its liabilities, which is an important factor in deciding whether a company is a risky or safe investment.
However, shareholders' equity is just one of many metrics an investor might consider when evaluating a company's financial health. You can also measure a company's financial health by reviewing its liquidity, solvency, profitability, and operating efficiency.