What Is Shareholder Equity (SE)?
For corporations, shareholder equity (SE), also referred to as shareholders' equity and stockholders' equity, is the corporation's owners' residual claim on assets after debts have been paid. Equity is equal to a firm's total assets minus its total liabilities.
Retained earnings is part of shareholder equity and is the percentage of net earnings that were not paid to shareholders as dividends. Retained earnings should not be confused with cash or other liquid assets. This is because years of retained earnings could be used for either expenses or any asset type to grow the business. Shareholders’ equity for a company that is a going concern is not the same as liquidation value. In liquidation, physical asset values have been reduced and other extraordinary conditions exist.
Formula and Calculation of Shareholder Equity
Shareholders’ equity=total assets−total liabilities
The formula above is also known as the accounting equation or balance sheet equation. The balance sheet holds the basis of the accounting equation.
The steps to calculate shareholder equity are as follows:
- Locate the company's total assets on the balance sheet for the period.
- Total all liabilities, which should be a separate listing on the balance sheet.
- Locate total shareholder's equity and add the number to total liabilities.
- Total assets will equal the sum of liabilities and total equity.
For some purposes, such as dividends and earnings per share, a more relevant measure is shares “issued and outstanding.” This measure excludes Treasury Shares (stock owned by the company itself).
What Shareholder Equity Can Tell You
Shareholder equity can be either negative or positive. If positive, the company has enough assets to cover its liabilities. If negative, the company's liabilities exceed its assets; if prolonged, this is considered balance sheet insolvency.
For this reason, many investors view companies with negative shareholder equity as risky or unsafe investments. Shareholder equity alone is not a definitive indicator of a company's financial health; used in conjunction with other tools and metrics, the investor can accurately analyze the health of an organization.
All the information needed to compute a company's shareholder equity is available on its 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, et al.). 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, shareholder equity can be determined.
Shareholder equity is an important metric in determining the return being generated versus the total amount invested by equity investors. For example, ratios like return on equity (ROE), which is the result of a company's net income divided by shareholder equity, is used to measure how well a company's management is using its equity from investors to generate profit.
Example of How to Use Shareholder Equity
For example, assume that ABC company has total assets of $2.6 million and total liabilities of $920,000. Therefore, ABC shareholder equity is $1.68 million.
As a real-world example, PepsiCo Inc.'s (NYSE: PEP) total stockholders' equity declined in the two year period from $17.4 billion in 2014 to $11.1 billion in 2016, which—depending on the reasons—might give analysts concern for the soda and snack food giant's health. In the same period, arch-rival Coca-Cola Corporation's (NYSE: KO) total shareholder equity fell from $30.3 billion to $23.01 billion. But the percentage drop isn't as great because Coke's liabilities and accounts payable also consistently decreased, while Pepsi's increased, suggesting Coke had a better handle on its debt.