How to Calculate Shareholder Equity With a Formula
Understand the fundamental calculation of shareholder equity to gain insight into a company's financial structure and owner claims.
Shareholder equity represents the owners’ claim on a company’s assets after all liabilities have been settled. It is a fundamental financial metric that provides insight into a company’s financial health and its underlying value. Analyzing shareholder equity helps in understanding how much of a company’s assets are financed by its owners versus creditors.
The Foundational Formula
The core relationship in accounting is expressed by the accounting equation: Assets = Liabilities + Shareholder Equity. This equation illustrates that a company’s assets, which are what it owns, are financed either by borrowing (liabilities) or by the owners’ contributions and accumulated profits (shareholder equity).
To calculate shareholder equity, this foundational equation can be rearranged. By subtracting total liabilities from total assets, the resulting figure reveals the shareholder equity: Shareholder Equity = Assets – Liabilities. Assets encompass everything a company owns that has economic value, such as cash, inventory, property, and equipment. Liabilities represent what the company owes to external parties, including loans, accounts payable, and deferred revenue.
Key Components of Shareholder Equity
Shareholder equity on a balance sheet is composed of several accounts, each representing a distinct source of owner financing. Common Stock and Preferred Stock represent the initial capital invested directly by owners through the purchase of shares. Common stock typically carries voting rights, while preferred stock often has priority for dividend payments and asset distribution in liquidation.
Additional Paid-in Capital (APIC) captures the amount shareholders paid for stock that exceeds its par or stated value. For instance, if a stock has a par value of $1 but sells for $10, the $9 difference per share is recorded as APIC. Retained Earnings represent the cumulative profits a company has earned since its inception that have not been distributed to shareholders as dividends. This accumulated profit is reinvested back into the business.
Treasury Stock is another component, but it acts as a contra-equity account, meaning it reduces total shareholder equity. This occurs when a company repurchases its own shares from the open market. Companies might buy back shares to reduce the number of outstanding shares, which can increase earnings per share, or to have shares available for employee stock options. The cost of these repurchased shares is recorded as treasury stock, directly lowering the overall equity balance.
Applying the Calculation
To apply the shareholder equity formula, the necessary data is found on a company’s balance sheet, one of the primary financial statements. Publicly traded companies in the United States are required to make their financial statements, including balance sheets, available to the public through regulatory filings. The balance sheet presents a snapshot of a company’s financial position at a specific point in time, listing its assets, liabilities, and shareholder equity.
Locate the “Total Assets” and “Total Liabilities” figures on the balance sheet. Assets are typically listed first, followed by liabilities and then shareholder equity. For example, imagine a hypothetical company, “Innovate Corp.,” reports total assets of $5,000,000 and total liabilities of $2,000,000 on its balance sheet. To calculate Innovate Corp.’s shareholder equity, subtract the total liabilities from the total assets: $5,000,000 (Total Assets) – $2,000,000 (Total Liabilities) = $3,000,000 (Shareholder Equity).