How to calculate stockholders' equity
/What is Stockholders’ Equity?
Stockholders’ equity represents the owners' residual interest in a company's assets after liabilities are deducted. It reflects the net worth of a business and is reported on the balance sheet under the equity section. A positive stockholders' equity indicates that a company has more assets than liabilities, while a negative balance may signal financial distress or excessive debt.
How to Calculate Stockholders’ Equity
The amount of stockholders' equity can be calculated several ways. These options are the balance sheet method, the accounting equation method, and the summation of equity components method. Each option is describe below.
Balance Sheet Method
The easiest approach is to look for the stockholders' equity subtotal in the bottom half of a company's balance sheet; this document already aggregates the required information. The applicable line item appears in the following exhibit.
Accounting Equation Method
If a balance sheet is not available, another option is to summarize the total amount of all assets and subtract the total amount of all liabilities. The net result of this simple formula is stockholders' equity.
Summation of Equity Components Method
If the preceding options are not available, it will be necessary to compile the amount from individual accounts in a company's general ledger. If so, the stockholders' equity formula is:
+ Common stock
+ Preferred stock
+ Additional paid-in capital
+/- Retained earnings
- Treasury stock
= Stockholders' equity
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Problems with the Stockholders’ Equity Concept
The amount of stockholders' equity is really more of a theoretical concept, for it does not accurately reflect the amount of funds that would be distributed to shareholders if a business were to be liquidated. The following valuation issues should also be considered:
Intangibles. There may be a number of valuable intangible assets, such as brands, that are not recognized in a company's balance sheet at all. Instead, the cost to establish and maintain these assets may have been charged to expense as incurred.
Market value. The recorded amounts of certain assets are not adjusted to reflect changes in their market value, such as fixed assets.
Future events. The sale price of a business will incorporate the expectations of the buyer and seller regarding future events, such as a decline in industry activity, or the reverse. These changes do not appear in the balance sheet.
In short, there are several ways to calculate stockholders' equity (all of which yield the same result), but the outcome may not be of particular value to the shareholder.