What Composes Stockholder Equity?
Stockholder equity, also known as shareholder equity, represents the amount of money investors paid for stock in the company, along with the accumulated retained earnings since the organization's beginning. Retained earnings are all net profits of the company that have not been previously distributed to stockholders in the form of dividends. Stockholder equity, at times, also includes donated capital, should the company receive gifts of funds or anything of value from individuals, governments or entities unaffiliated with the company.
Company Stock Sales
When a company sells its stock directly to the purchaser, it raises shareholder capital. When starting up, corporations sell some or all of the shares they create in their official filing as a new entity with their state government. Frequently, companies will not sell all of the stock they authorize at inception, saving some shares for future sales, should they need more capital after startup.
Corporations usually record net profits annually. After subtracting expenses from revenues and paying required federal, state and local income taxes, they should have net profit. Corporations can then decide to retain these profits or pay out some or all of it to stockholders in the form of dividends. The portion of net profit that corporations do not distribute to shareholders is called retained earnings.
Calculating Stockholder Equity
The formula for calculating stockholder equity is simple. Subtract a corporation's total liabilities, including debt, accrued expenses and taxes due, from the organization's total assets. The remainder is the company's stockholder equity. This will never be a negative number for a healthy company. Should stockholder equity equal less than paid-in capital -- money from selling shares -- it means the corporation has had losses in excess of profits over its history.
Stockholder equity is categorized by accountants as the book value of the company. Book value isn't always relevant to the true value of the corporation if it were for sale. It is the value that is reported on the corporation's balance sheet. However, should the company have been successful for many years, but encountering sales or financial problems currently, real stockholder equity may be less than book value. Conversely, a company that had minimal success generating profits since startup may have current profit prospects that make its true stockholder equity higher than book value.