A company’s financial statement consists of three principal components, namely – assets, liabilities and shareholder’s equity. Each of these components plays an essential role in determining the financial health of a company, making it easier for investors to analyse the company’s sustainability in the long run.
Shareholders equity is defined as the difference between total assets and total liabilities. It shows how much the owners of a company have invested in the business either by investing money in it or by retaining earnings over time.
It is also called Share Capital, Stockholder’s Equity or Net worth.
HOW TO CALCULATE SHAREHOLDER’S EQUITY
The shareholders’ equity is the remaining amount of assets available to shareholders after the debts and other liabilities have been paid.
It can be calculated by using the basic accounting equation :-
Shareholders’ Equity = Total Assets – Total Liabilities
It is the basic accounting formula and is calculated by adding the company’s long term as well as current assets and subtracting the sum of long term liabilities plus current liabilities from it.
For example: If a company has total assets of Rs 50,000 and total liabilities of RS 30,000, then the Shareholder’s equity will be
Rs 50,000 – Rs 30,000 = Rs 20,000
The shareholder’s equity can also be calculated by using the following formula :-
Shareholders Equity = Share Capital + Retained Earnings – Treasury Shares
This formula is known as the investor’s equation where you have to compute the share capital and then ascertain the retained earnings of the business.
IMPORTANCE OF SHAREHOLDER’S EQUITY
It is an important metric which can help the investors in determining the financial health of a firm before taking investment decisions.
A company’s shareholder’s equity can either be positive or negative.
A positive SE represents excess of assets over liabilities in a firm which is an indicator of sound financial health of the company.
On the other hand, a negative SE represents excess of liabilities over assets of the firm, which indicates that company doesn’t have a sound financial health & may lead to insolvency.
Thus, in simple words, Shareholder’s equity refers to the residual amount that the business owners would receive after all the assets are liquidated and all the debts are paid and serves as an important indicator of a company’s financial standing.