How Do You Calculate Shareholders’ Equity?

Shareholders’ equity represents the net worth of a company: the dollar amount that would be returned to shareholders if a company’s total assets were liquidated and all its debts were repaid. This financial metric is typically listed on a company’s balance sheet and is commonly used by analysts to determine the company’s overall fiscal health.

Shareholders’ equity is also used to determine the value of ratios such as:

• Debt-to-equity ratio (D/E)
• Return on equity (ROE)
• Return on average equity (ROAE)
• Book value of equity per share (BVPS)

Key Takeaways

• Shareholders’ equity represents the net worth of a company.
• Net worth is the amount that would be returned to shareholders if a company’s total assets were liquidated and all its debts were repaid from the proceeds.
• This financial metric is frequently used by analysts to determine a company’s general financial health. 
• Shareholders’ equity can be calculated by subtracting total liabilities from its total assets, both of which are itemized on a company’s balance sheet. 

How to Calculate Shareholders’ Equity

Shareholders’ equity can be calculated by subtracting its total liabilities from its total assets, both of which are itemized on a company’s balance sheet. 

Shareholders’ Equity=Total Assets − Total Liabilities

Total assets can be categorized as either current or non-current. Current assets are those that can be converted to cash within a year such as accounts receivable and inventory. Long-term assets are those that can’t be converted to cash or consumed within a year such as real estate properties, manufacturing plants, equipment, and intangible items like patents.

Total liabilities are also broken down into current and long-term categories. Current liabilities are debts that are due for repayment within one year such as accounts payable and tax obligations. Long-term liabilities are those that are due for repayment in periods beyond one year and include bonds payable, leases, and pension obligations.

Important

Shareholders’ equity most often represents the amount of financing a company experiences through common and preferred shares but it can also be calculated by subtracting the value of treasury shares from a company’s share capital and retained earnings.

Example of Shareholders’ Equity Calculation

Consider this actual balance sheet for Bank of America Corporation (BAC), taken from their 2020 annual report. Bank of America had total assets of $2.82 trillion and total liabilities of $2.55 trillion. Its total shareholders’ equity or assets minus liabilities was therefore $273 billion at that time.

Shareholders’ equity includes preferred stock, common stock, retained earnings, and accumulated other comprehensive income.

What Are Retained Earnings?

Retained earnings are the portion of a company’s profits that isn’t distributed to shareholders. Retained earnings are typically reinvested back into the business either through the payment of debt, to purchase assets, or to fund daily operations.

What Is Share Capital?

Share capital is the money a company raises by selling its shares to shareholders in exchange for cash. It’s the capital received for shares.

Is Shareholders’ Equity a Strong Indication of a Company’s Financial Health?

Shareholders’ equity isn’t a permanent carved-in-stone number. You’re using information from the company’s balance sheet so it can be difficult to pinpoint the accuracy of depreciation and other factors. You’re effectively taking the company’s word for these numbers.

A company’s assets and liabilities can change at any time as well due to unforeseen circumstances.

The Bottom Line

Shareholders’ equity can be negative or positive. The company has sufficient assets to cover its liabilities if it’s in positive territory. Its liabilities exceed assets if it’s negative and this can deter investors who view such companies as risky. Shareholders’ equity isn’t the sole indicator of a company’s financial health, however. It should be paired with other metrics to obtain a more holistic picture of an organization’s standing.

Read the original article on Investopedia.