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 stockholder equity can increase. One method involves making profits, while the other requires further financing from investors.
Stockholders' equity can increase essentially in two ways. One is for either existing or new shareholders to put more money into the company, so an investment by the stockholders in a business increases, and the other is for the company to make and hold on to a profit.
Exploring Stockholder Equity
Stockholders' equity, or owners 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 its assets minus liabilities, or $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.
Shareholder equity can easily be computed using the assets and liabilities computation if you have those numbers, and it's often explicitly spelled out on the balance sheet of publicly traded companies. That is available from the company, through the Securities and Exchange Commission or through various online finance news and brokerage sites.
Understanding Net Revenue
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.
Evaluating Capital Contributions
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.
Note that if a company takes in money by borrowing, then shareholder equity will not increase. That's because while the loan will bring more funds into the company, it will also create a corresponding liability, so there won't be a net gain in assets minus liabilities. In fact, loans will usually decrease shareholder equity since the liability created including interest will be greater than the asset added to the company's balance sheet.
Decreases in Stockholder 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.
In some cases, a company might actually borrow money and use the funds to issue dividends or buy back stock from investors. In this case, shareholders' equity will decrease even more, since the company is paying out money and taking on a loan liability at the same time. It can still be advantageous to a company to do so, since it can help to make shareholders happy and can also let the company deduct the cost of loan interest from its taxes. The cost of dividends or buybacks is generally not deductible.
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