What Is Stockholders’ Equity?

Stockholders’ equity is the remaining assets available to shareholders after all liabilities are paid. It is calculated either as a firm’s total assets less its total liabilities or alternatively as the sum of share capital and retained earnings less treasury shares. Stockholders’ equity might include common stock, paid-in capital, retained earnings, and treasury stock.

Conceptually, stockholders’ equity is useful as a means of judging the funds retained within a business. If this figure is negative, it may indicate an oncoming bankruptcy for that business, particularly if there exists a large debt liability as well.

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How to Calculate Stockholders’ Equity

You can determine shareholders’ equity by calculating the total assets and liabilities using the following formula:

Stockholder’s Equity = Total Assets − Total Liabilities text{Stockholder’s Equity} = text{Total Assets} – text{Total Liabilities} Stockholder’s Equity=Total Assets−Total Liabilities

All the information required to compute shareholders’ equity is available on a company’s balance sheet, including total assets:

• Current Assets: These are assets that can be converted to cash within a year. These include cash, accounts receivable, and inventory.
• Non-Current Assets: This category includes long-term assets that cannot be converted to cash or consumed within a year, such as 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, including accounts payable and taxes payable. Long-term liabilities are obligations that are due for repayment in periods longer than one year, such as bonds payable, leases, and pension obligations.

How Stockholders’ Equity Works

Stockholders’ equity is often referred to as the book value of the company and it comes from two primary sources:

1. The first source is the money originally and subsequently invested in the company through share offerings.
2. The second source consists of the retained earnings (RE) the company accumulates over time through its operations.

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In most cases, retained earnings are the largest component of stockholders’ equity. This is especially true when dealing with companies that have been in business for many years.

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. If used in conjunction with other tools and metrics, the investor can accurately analyze the health of an organization.

Stockholders’ Equity and Retained Earnings (RE)

Retained earnings are a company’s net income from operations and other business activities retained by the company as additional equity capital. Retained earnings are thus a part of stockholders’ equity. They represent returns on total stockholders’ equity reinvested back into the company.

These earnings, reported as part of the income statement, accumulate and grow larger over time. At some point, accumulated retained earnings may exceed the amount of contributed equity capital and can eventually grow to be the main source of stockholders’ equity.

Stockholders’ Equity and Paid-in Capital

Companies fund their capital purchases with equity and borrowed capital. The equity capital/stockholders’ equity can also be viewed as a company’s net assets. You can calculate this by subtracting the total assets from the total liabilities.

Investors contribute their share of paid-in capital as stockholders, which is the basic source of total stockholders’ equity. The amount of paid-in capital from an investor is a factor in determining his/her ownership percentage.

Stockholders’ Equity and the Impact of Treasury Shares

Companies may return a portion of stockholders’ equity back to stockholders when unable to adequately allocate equity capital in ways that produce desired profits. This reverse capital exchange between a company and its stockholders is known as share buybacks. Shares bought back by companies become treasury shares, and their dollar value is noted in the treasury stock contra account.

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Treasury shares continue to count as issued shares, but they are not considered to be outstanding and are thus not included in dividends or the calculation of earnings per share (EPS). Treasury shares can always be reissued back to stockholders for purchase when companies need to raise more capital. If a company doesn’t wish to hang on to the shares for future financing, it can choose to retire the shares.

Example of Stockholders’ Equity

Below is the balance sheet for Apple (AAPL) as of July 1, 2023. For that period:

• Total assets were $335.0 billion
• Total liabilities were $274.8 billion

Stockholders’ equity was, therefore, $60.2 billion ($335 – $274.8).

Looking at the same period one year earlier, we can see that the year-over-year (YOY) change in equity was an increase of $9.5 billion. The balance sheet shows this decrease is due to a decrease in assets, but a larger decrease in liabilities.

The value of $60.2 billion in shareholders’ equity represents the amount left for stockholders if Apple liquidated all of its assets and paid off all of its liabilities.

An alternative calculation of company equity is the value of share capital and retained earnings less the value of treasury shares.

Stockholders’ equity is an effective metric for determining the net worth of a company, but it should be used in tandem with the analysis of all financial statements, including the balance sheet, income statement, and cash flow statement.

The Bottom Line

Investors and analysts look to several different ratios to determine the financial company. One of these is a company’s return on equity. This shows how well management uses the equity from company investors to earn a profit. Part of the ROE ratio is the stockholders’ equity, which is the total amount of a company’s total assets and liabilities that appear on its balance sheet.

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