Shareholders' equity represents the net value of a company, or the amount that would be returned to shareholders if all of a company's assets were liquidated and all its debts repaid. In short, shareholders' equity measures a company's net worth. It can be found on a company's balance sheet, and it's a common financial metric used by analysts to determine the financial health of a company.
How to Calculate Shareholders' Equity
You can calculate a company's shareholders' equity by subtracting its total liabilities from its total assets, which are listed on the company's balance sheet. The formula for calculating shareholder equity is:
Shareholders’ Equity=Total Assets − Total Liabilities
Shareholders' equity represents the amount of financing the company experiences through common and preferred shares. Shareholders' equity could also be calculated by subtracting the value of treasury shares from a company's share capital and retained earnings.
Example of Shareholders' Equity Calculation
Below is the balance sheet for Bank of America Corporation (BAC) as of the end of 2017, from their annual 10K statement. As of December 31, 2017, Bank of America had total assets of $2.281234 trillion and total liabilities of $2.014088 trillion.
So, at the time, Bank of America's total shareholders' equity was: $2.281234 (assets) – $2.014088 (liabilities) = $267.146 billion.
We can also see the line item on the balance sheet (in green) for shareholders' equity. The number is also broken out by each component, including preferred stock, common stock, retained earnings, and accumulated other comprehensive income (or loss) that net to the shareholders' equity total.
Shareholders' equity can also be calculated as: $22.323 + 138.089 + 113.816 – 7.082 = $267.146 billion.
The value of $267.146 billion in shareholders' equity represents the amount left for shareholders if Bank of America paid off all of its liabilities.
What Insight Does Shareholders' Equity Provide?
Shareholders' equity can be either negative or positive. If positive, the company has sufficient assets to cover its liabilities. If negative, the company's liabilities exceed its assets; if prolonged, this is considered balance sheet insolvency.
As such, many investors view companies with negative shareholders' equity as risky investments. Shareholders' equity by itself is not a sufficient indicator of a company's financial health. However, when paired with other tools and metrics, it is a good tool to help an investor accurately analyze the health of an organization.
All statistics needed 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.
Market watchers and analysts prefer to see a stable balance between the amount of retained earnings that a company pays to investors in the form of dividends and the amount retained to reinvest back into the company. Shareholders' equity is an essential metric for figuring out the return being generated versus the amount invested by equity investors.