What is the Stockholders’ Equity Equation?
The stockholders’ equity equation may be used on its own, with a negative value being seen as a portent of looming bankruptcy. However, it’s more commonly used in conjunction with figures like total debt to give an overall assessment of how well a business manages its finances.
What is stockholders’ equity?
Known as shareholders’ equity or the book value of a business, the stockholders’ equity uses the total assets and liabilities of a company. The equation results in a dollar value that can be assigned to the business. It’s used by accounting firms and departments as the value of all liquidated assets that would be shared between shareholders. The figure is usually lower than the organization’s market value.
The stockholders’ equity equation
The equation to calculate stockholders' equity is:
Stockholders' equity = total assets - total liabilities
You can find the value of total assets and total liabilities from an organization’s balance sheet.
All assets, including long-term or non-current assets, should be included in the calculation. This not only includes property and equipment but also intangible assets like patents. Non-current assets are those that would take longer than a year to convert to cash. Current, or short-term, assets can be liquidated in less than a year and include cash and inventory.
Similarly, long-term liabilities should also be calculated. Long-term liabilities can include bonds, leases, and any pension and benefits liabilities. Short-term liabilities are those that will need repaying within one year, such as annual taxes.
Businesses often include the stockholders’ equity calculation on their balance sheet. Even if the figure isn’t explicitly stated, it can be calculated from the provided information.
Uses for stockholders’ equity
Stockholders’ equity is commonly included in an organization’s balance sheet. It’s used by analysts as a way to assess an organization’s financial health.
Because it can be considered a measurable value of a business, it’s also used by investors, along with share price and ratios like earnings per share, to determine whether a stock is under-priced or overpriced. Consequently, it can be used to measure the value of a potential investment.
What it represents
Using the equation above, stockholders’ equity will usually be lower than market value, and it can either be positive or negative.
- Positive - A positive equity shows that a company has the assets to cover all of its liabilities. It means that if all the company’s assets were liquidated and all debts repaid, there would be cash left to pay shareholders.
- Negative - A negative equity, on the other hand, means that the business does not have enough assets to meet its liabilities. This should be viewed as a red flag because it means that the company is likely to be unable to meet all of its repayment obligations. Negative stakeholders’ equity is often seen as a precursor to bankruptcy.
The stockholders’ equity figure can usually be seen on the balance sheet of a publicly-traded company and is calculated by taking total liabilities from a business’s total assets. A positive figure is a sign of good fiscal quality and means that a company can repay all of its outstanding liabilities. A negative figure can be a sign of impending or future bankruptcy and should be seen as a red flag by investors.