When you invest in stock, an important figure to be familiar with is stockholders' equity in the company. This is the amount of money that can potentially be paid out to investors. But you should also understand the two ways that stockholders' equity can increase. One method involves making profits, while the other requires further financing from investors.
Stockholders' equity is the difference between a firm's total liabilities and total assets. For example, if a company has total assets of $6.5 milllion and total liabilities of $1.5 million, then it has stockholders' equity of $5 million. The board of directors decides what to do with stockholder's equity, either returning it to the individual stockholders through a dividend or reinvesting it in the company.
Net revenues, or profits, are the firm's total revenues less its total expenses. Net revenues have the effect of increasing the firm's assets. Because stockholders' equity is he difference between the firm's assets and liabilities, it also has the effect of increasing the stockholders' equity. For instance, if a firm has net revenues of $100,000, then its assets would increase by the same amount, resulting in a $100,000 increase in stockholders' equity.
Capital contributions are the funds that investors put into a company when they purchase stock from it. Capital contributions increase the firm's cash assets, therefore resulting in an increase to stockholders' equity. For example, if a firm issues 1,000 shares at $10 a piece, then it would receive $10,000 for the shares. This would increase the company's assets by $10,000, meaning there would be a $10,000 increase in stockholders' equity.
Stockholders' equity can decrease just as easily -- if not more so -- than it increases. When a firm issues a dividend, it pays out earnings to the stockholders using its assets. This causes a decrease in assets, meaning that the stockholders' equity decreases. Also, if a firm has net losses instead of net revenues, this will also decrease the firm's assets and cause the stockholders' equity to decrease.
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