Shareholders' equity represents the net worth of a company, which is the dollar amount that would be returned to shareholders if a company's total assets were liquidated, and all of its debts were repaid. Typically listed on a company's balance sheet, this financialmetricis commonly used by analyststo determine a 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, which is the amount that would be returned to shareholders if a company's total assets were liquidated and all of its debts repaid.
- This financial metric is frequently used by analysts to determine a company's general financial health.
- Shareholders' equity may be calculated by subtracting its total liabilities from its total assets, both of which are itemized on a company's balance sheet.
How to Calculate Shareholders'Equity
Shareholders'equity may be calculated by subtracting itstotal liabilities from its total assets—both of which are itemized on a company's balance sheet.
Shareholders’Equity=TotalAssets−TotalLiabilities
Total assets can be categorized as either current or non-current assets.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 cannot be converted to cash or consumed within a year, such as real estate properties, manufacturing plants, equipment, and intangible items like patents.
Total liabilities consist of current liabilities and long-term liabilities. Current liabilities are debts that are due for repayment within one year, such as accounts payable and taxes payable.Long-term liabilities are obligations that are due for repayment in periods beyond one year, including bonds payable, leases, and pension obligations.
Although shareholders'equity most often represents the amount of financing a company experiences through common and preferred shares, it can also be calculated by subtracting the value of treasury shares from a company's share capital andretained earnings.
Example of Shareholders'EquityCalculation
Consider the following actual balance sheet forBank of AmericaCorporation (BAC), taken from their annualreport.On Dec.31, 2020, Bank of Americahad total assets of $2.82trillionandtotal liabilities of $2.55trillion. So, at the time, Bank of America'stotal shareholders'equity was $273billion (or assets minus liabilities).
Shareholders' equity includes preferred stock, common stock, retained earnings, and accumulated other comprehensive income.
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What Insight Does Shareholders' Equity Provide?
Shareholders' equity can be either negative or positive. If it's in positive territory, the company has sufficient assets to cover its liabilities. If it's negative, its liabilities exceed assets, which may deter investors, who view such companies as risky investments. But shareholders' equity isn't the sole indicator of a company's financial health. Hence, it should be paired with other metrics to obtain a more holistic picture of an organization's standing.
