Definition of Shareholders’ Equity and an Example
Shareholders’ equity is the value of the company’s assets remaining after liabilities have been deducted and is found on the financial statement and the statement of shareholders’ equity. Shareholders’ equity is an indicator of the financial stability of the company and its flexibility in the event of an economic or financial downturn. Understanding shareholders’ equity is a way for investors to gauge the financial health of the company.
How Does Shareholders’ Equity Work?
Shareholders’ equity often comes from three sources:
- Paid-in capital: This is the cash or other assets contributed by investors when the company was raising capital; in exchange for issuing common or preferred stock.
- Additional paid-in capital: Also known as “Paid-in Capital,” this is the capital that investors contribute over the par value of the shares. It does not include stock generated from profits or donations.
- Retained earnings: These are the accumulated profits that the company has kept to reinvest in the business. They are not distributed to shareholders as dividends or used for stock buybacks.
The list of assets is often displayed on the left side of the company’s financial statement, with liabilities and shareholders’ equity displayed on the right side. Some financial statements may present assets at the top, followed by liabilities, and finally show shareholders’ equity at the bottom.
The total assets should equal total liabilities plus shareholders’ equity.
Alternatives to Shareholders’ Equity
When making investment decisions, shareholders’ equity should not be the only thing you look at. A single data point in the company’s financial statement cannot tell you whether it is a good risk or not.
To make more informed investment decisions, you should look at shareholders’ equity on the financial statement along with:
- Annual reports: These are yearly reports on the financial status of the company; they may also include details about objectives, management, leadership, and culture.
- Form 10-K: This filing is required by the Securities and Exchange Commission (SEC). It provides an overview of the company’s financial condition; it is sometimes sent to shareholders instead of the annual report.
- Debt-to-equity ratio: This compares assets with liabilities. It can help you identify a company carrying too much debt.
- Price-to-earnings ratio: This compares the share price with the company’s earnings per share. High ratios indicate more growth opportunities.
- Industry stability and growth: This information provides context regarding potential opportunities for the company to grow profitably.
- Dividends: These payments can indicate stability and growth unless they represent a very high percentage of earnings.
- Income statement: This allows you to compare earnings, expenses, and net income over time.
By examining shareholders’ equity alongside these other metrics, you can form a complete picture of the company and make a wise investment decision.
Source: https://www.thebalancemoney.com/shareholders-equity-on-the-balance-sheet-357295
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