What Is Stockholder's Equity? Definition and Formula
By Indeed Editorial Team
Updated September 3, 2021 | Published February 4, 2020
Updated September 3, 2021
Published February 4, 2020
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
When used with other metrics, stockholder's equity can be a great way to determine a business's financial standing. In general, knowing the stockholder's equity allows you to quantify your company's net worth. For example, if your stockholder's equity is a positive number, this means your company will be able to pay off its liabilities and you should be in good financial standing.
A negative number could indicate your company's assets are less than its liabilities. In some cases, this could mean your company might be facing potential bankruptcy. Once you determine the stockholder's equity, you can ascertain whether or not you need to make changes for the betterment of your corporation. In this article, we will define stockholder's equity, how to calculate it and useful tips for improving it.
Related: Learn About Being an Accountant
What is stockholder's equity?
Stockholder's equity is the total value of assets owned by an investor after deducting and settling liabilities. It's also referred to as shareholder's equity or a company's book value. Similar to owner's equity, stockholder's equity is the difference between assets and liabilities, but it's in relation to a business. Calculating stockholder's equity is a great way to start to understand the health of a corporation.
Related: Your Guide To Careers in Finance
What is included in stockholder's equity?
Stockholder's equity is found on the balance sheet reported as paid-in capital, retained earnings, accumulated other comprehensive income, treasury stock, preferred stock and common stock. They are defined as follows:
Paid-in capital: Paid capital is the capital a corporation receives from investors when they issue shares of common and preferred stock.
Retained earnings: This refers to a company's total profits after paying off dividends to shareholders.
Accumulated other comprehensive income: This is comprised of revenues, expenses, gains and losses that are not included in the net income on an income statement.
Treasury stock: Treasury stock encompasses the outstanding shares of stock that a company has repurchased from stockholders.
Preferred stock: Preferred stock is stock in which dividends take precedence. In other words, shareholders will be paid dividends before common stockholders are.
Common stock: Common stock refers to shares that are representative of corporate ownership.
How to calculate stockholder's equity
Calculating stockholder's equity can help you start to understand your company's financial situation. Though it could potentially predict a future bankruptcy, knowing your stockholder's equity will let you know whether or not you'll need to take the steps to help your business stay afloat. Stockholder's equity is calculated by subtracting a corporation's liabilities from its assets. Use the following equation to calculate stockholder's equity:
Total assets - total liabilities = stockholder's equity
Stockholder's equity can also be calculated by taking the sum of share capital and retained earnings and deducting treasury stock. The equation for this would be:
Share capital + retained earnings - treasury stock = total shareholder's equity
Though calculating stockholder's equity isn't an all-encompassing look at your corporation's financial stability, it can provide a general indication of its current and future status.
Here are a few examples of stockholder's equity in action:
As of December 2018, your bank had accumulated assets of $3 million. It also had total liabilities amounting to $2 million. This means that then, the bank's total stockholder's equity was $1 million. This is because: $3 million (assets) - $2 million (liabilities) = $1 million (stockholder's equity). This dollar amount is how much stockholders will have after your bank paid off all of its liabilities. This stockholder's equity will be reported on the balance sheet by showing each component that makes up the stockholder's equity such as common stock, preferred stock, retained earnings, accumulated other comprehensive income and more.
If your child's lemonade stand had $50 in assets for the week but $20 in liabilities, the stockholder's equity would amount to $30. This is because $50 (assets) - $20 (liabilities) = $30 (stockholder's equity). This positive number could mean the lemonade stand is in good financial health.
By November 2019, your small business has total assets of $10,000. Your business also has $7,000 in total liabilities. This means that by November 2019, your business's total stockholder's equity was $3,000. In other words, $10,000 (assets) - $7,000 (liabilities) = $3,000 (stockholder's equity). The $3,000 is what stockholders have after your small business has paid off all of its liabilities.
What does an increase or decrease indicate?
If you're regularly calculating stockholder's equity, you've likely noticed an increase or decrease. Here are the potential reasons behind both:
Increasing stockholder's equity
There are several reasons why stockholder's equity could increase over time, such as:
Change in how assets are valued
Greater retained earnings
More capital added by shareholders
Decreasing stockholder's equity
Here are some reasons why you might see a decrease in stockholder's equity:
Depreciation of assets
Repurchasing of outstanding shares
More treasury shares
Increase in expenses
Reduced retained earnings
Dividends issued to shareholders
How to improve stockholder's equity
If your company is in poor financial standing with a negative stockholder's equity, you might consider implementing various tactics in an attempt to increase stockholder's equity. Here are several ways to improve your company's net worth, or in other words, your stockholder's equity:
1. Decrease liabilities
By decreasing the number of liabilities, you increase the amount of overall stockholder's equity. Consider lowering your debt obligations or lowering your business expenses to decrease liabilities.
2. Increase retained earnings
If your business is more profitable, you'll see an increase in retained earnings. To increase retained earnings, consider laying off employees, reducing any benefits or bonuses you have in place and using more economical equipment and machinery. If you increase your corporation's sales revenue, this will positively affect your retained earnings, as well.
3. Sell depreciated assets
Another way to increase stockholder's equity is to determine any assets your company owns that have depreciated over time. These assets can be liquidated (converted into cash) in hopes of making a profit.
4. Increase paid-in capital
If a shareholder makes a contribution to a business in the form of cash or other means, their investment's value in the business along with the value of each outstanding share will rise. This would appear on the balance sheet as an increase in stockholder's equity.
It's important to remember that calculating the stockholder's equity can be beneficial, but must be used alongside other tools to provide you with an accurate depiction of your company's net worth.
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