Shareholder Equity: Definition And Examples

It’s important to analyze a company’s balance sheets before making any significant investment in them.

However, you may not understand the specific terms on their balance sheets mean or represent. This article focuses on one of the most common of these terms — shareholder equity.

We’ll discuss what shareholder equity means and how to calculate it. You’ll also learn why it’s an important metric in a company and how to interpret it.

What Is Shareholder Equity?

Shareholders’ equity refers to the net value of a company. It’s an important line item that you can find on any public company’s balance sheet and is commonly used by investors and analysts to determine the health of a company.

Equity represents the total amount of money that shareholders would own if the company liquidated all its assets and paid down all its debts.

In the case of a company acquisition, shareholders’ equity can be calculated from the value of the sale less any existing liabilities not transferred with the sale.

For any particular shareholder, their equity represents their pro-rata ownership of the company. Shareholder equity is also commonly offered as a form of payment-in-kind, typically in exchange for investment capital.

How to Calculate Shareholder Equity

Calculating a company’s shareholder equity is relatively simple as long as you can access their recent balance sheets.

The accounting equation is given below:

Shareholder Equity = Total Assets – Total Liabilities

You can locate all the necessary information to use this formula by following these steps:

1. Find the company’s total assets for the current period on their balance sheet.

2. Find their total liabilities, which will be separately listed on the balance sheet.

3. Subtract the company’s total liabilities from their total assets, giving you shareholder equity.

Another method for arriving at the same value for a company’s shareholder equity is subtracting the value of their treasury shares from the sum of their share capital and their retained earnings for the current period.

Here are some definitions to help you better understand the components involved in calculating shareholder equity:

Total assets consist of:

1. Current assets. These assets can quickly convert into cash, such as accounts receivable, inventory, and cash equivalents.

2. Long-term assets. Long-term assets are assets that the company would not likely be able to convert into cash within a year.

   These include patents, heavy equipment, and facilities.

Total liabilities consist of:

1. Current liabilities. These are debts that the company needs to repay within a year.

   Examples include accounts payable and taxes payable.

2. Long-term liabilities. Liabilities that are due for repayment more than a year into the future.

   These include pension obligations, long-term leases, and bonds payable.

Example Shareholder Equity Calculations

Here are some sample calculations using hypothetical companies to illustrate exactly how to calculate shareholder equity:

• Company A. For Q3, total assets were $3.43 million, and total liabilities were $1.21.

  Shareholder equity = $3.43 – $1.21 = $2.22 million

• Company B. For Q4, total assets were $432,222, and total liabilities were $121,100.

  Shareholder equity = $432,222 – $121,100 = $311,122

Why is Shareholder Equity Important?

Now that you know how to calculate a company’s shareholder equity, you may be wondering how to interpret it.

Here are some reasons why shareholder equity is an important value:

• Stake. Equity represents how much ownership a given party holds over a company.

  Shareholder equity allows shareholders to vote on corporate actions and elections that may change the board of directors. This allows them to steer the course of the company and impact their chances for future success.

• Capital gains. Equity entitles shareholders to any dividends that the company may issue.

  However, this depends on the type of company. Technology companies, for example, tend to retain and invest their earnings rather than issue dividends.

  Shareholder equity may also come in the form of common or preferred stock, which may change what benefits any particular shareholder is entitled to.

• Company health. Total liabilities, one component of the shareholder value formula, represent the long and short-term debts a company owes.

  If a company doesn’t have enough assets to cover its liabilities for a prolonged time, this could lead to insolvency and even bankruptcy.

  However, keep in mind that low or negative shareholder equity is not always a sure sign of incoming bankruptcy but rather one of many metrics you should use to determine a company’s health.

  For example, company A could have negative shareholder equity at the end of a quarter. However, if they also grew their profits by 200%, they might be able to grow that equity before their liabilities overwhelms them quickly.

  Conversely, suppose that company B shows significant shareholder equity but decreased earnings.

  They may not be the smartest investment because if their earnings continue to decline, they may begin to shed shareholder equity each quarter rather than grow it.

  The takeaway here is that shareholder equity is an important metric for determining the health of a company, but it’s still only a single metric.

  You should always consider it in conjunction with other factors.

• Return on equity (RoE). You can compare a company’s profits against its shareholders’ equity to measure how well its management is deploying capital.

  Two companies may generate the same earnings each quarter, but if one is doing so with significantly less capital, that company may be much more attractive to investors.

Components of Shareholder Equity

We’ve already covered how to calculate a company’s shareholder equity by simply subtracting their total liabilities from their total assets.

However, here’s a more in-depth look into the components that go into any equity calculation.

Additional components that are included in shareholder equity include:

• Outstanding shares. This includes both preferred and common stock. Common stock is typically sold on public markets, while the preferred stock may only be offered to employees and other insiders.

• Additional Paid-In Capital (APIC). APIC represents the difference between the par-value of company shares and the price at which they were initially issued.

  For example, suppose a company IPOs at $4 per share. Two months later, their stock price is now at $5. Their balance sheets would therefore list an APIC of $1 per share.

• Retained earnings. When a company generates profit in a quarter and does not pay it out as a dividend, that amount is added to shareholder equity.

• Treasury stock. Treasury stock represents shares that the company has bought back from investors.

  This is typically done for various reasons, such as to prevent hostile takeovers, re-issue at a later date, or simply boost the company’s stock price.

  Treasury stock reduces shareholder equity on a balance sheet, as it represents equity purchased away from shareholders.

The Difference Between Private and Public Equity

Simply put, private equity refers to ownership of a private company’s shares, while public equity is ownership of company shares listed on public markets.

You can calculate both forms of shareholder equity using the process we covered earlier – by subtracting total liabilities from total assets.

The main difference between public and private equity is the type of investors that typically hold them.

Public companies offer a portion of their equity to public investors on exchanges such as the New York Stock Exchange (NYSE). Purchase is typically open to almost anyone.

On the other hand, private companies typically only sell equity to a limited range of groups and individuals.

These include:

• Accredited individuals (net worth of over $1 million)

• Pension funds

• Endowments

• Insurance companies

Companies that offer private equity are often, but not always, companies early in their life cycles looking to secure investment capital to fund their operations and growth.

Another common situation where private equity is changed is during a leveraged buyout (LBO). Companies looking to acquire another company or a division of a company will often secure a loan from a private equity firm by exchanging their equity.

Other Types of Equity

Although many use the terms equity and shareholder equity interchangeably, they’re not necessarily the same.

To help you understand the differences, here are some ways that the concept of equity is applied when it comes to investing:

• Margin trading. Equity commonly refers to the value of an account’s securities less the amount of money that the account holder has borrowed from the brokerage.

• Real estate. A homeowner’s equity in a piece of property can be calculated by subtracting their remaining mortgage from the home’s fair market value.

  Also commonly referred to as real property value, homeowner equity represents how much an individual would receive after selling a property and paying off any liens.

• Brand equity. Brand equity is a fairly nebulous and often hard-to-calculate component of shareholder equity.

  It’s part of a company’s intangible assets and represents the value of its brand and reputation in generating revenue.

  A company’s accountants will measure their brand equity by comparing the prices of their products against those of competitors.

  If Brand A can sell 100 units of their product at $2 while their competitors can only sell that same volume at 1$, their brand equity can be $1 per unit.

  Brand equity can also be negative in cases when consumers associate negative things with the company.

  This is becoming especially common in recent years, with consumers becoming increasingly aware of how companies treat their employees and the environment.

• Ownership equity. A company’s ownership equity (also called its risk capital) is the amount of money leftover if it liquidated its assets and paid off its creditors.

  Investors often use this figure to determine the worst-case or baseline value of a company if it goes bankrupt.

  However, you shouldn’t treat it as a perfect tool as poor management could easily lead to a company shedding significant shareholder equity before any such bankruptcy or liquidation event.

Author

Chris Kolmar

Chris Kolmar is a co-founder of Zippia and the editor-in-chief of the Zippia career advice blog. He has hired over 50 people in his career, been hired five times, and wants to help you land your next job. His research has been featured on the New York Times, Thrillist, VOX, The Atlantic, and a host of local news. More recently, he's been quoted on USA Today, BusinessInsider, and CNBC.