8. How Do You Calculate a Company’s Equity?¶
The equity of a company, or shareholders’ equity, is the net difference between a company’s total assets and its total liabilities. A company’s equity is used in fundamental analysis to determine its net worth.
Shareholders’ equity represents the net value of a company, or the amount of money left over for shareholders if all assets were liquidated and all debts repaid.
8.1. How to Calculate Shareholders’ Equity¶
The formula for calculating shareholders’ equity is:
Shareholder’s Equity = Total Assets − Total Liabilities
You can find a company’s total liabilities and total assets on its balance sheet.
8.2. Example of Shareholders’ Equity¶
Below is the balance sheet for Apple Inc. (AAPL) as of March 31, 2018.
Total assets (in green) were $367.502 billion Total liabilities (in red) were $240.624 billion Shareholders’ equity was $126.878 billion ($367.502 - $240.624)
The value of $126.878 billion in shareholders’ equity represents the amount left for shareholders if Apple liquidated all of its assets and paid off all of its liabilities.
An alternative calculation of company equity is the value of share capital and retained earnings less the value of treasury shares.
Shareholders’ equity is an effective metric for determining the net worth of a company, but it should be used in tandem with analysis of all financial statements, including the balance sheet, income statement, and cash flow statement.
8.3. Why Is Shareholders’ Equity Important?¶
Shareholders’ equity can be negative or positive. If it reads positive, the company has enough assets to cover its liabilities. If negative, the company’s liabilities exceed its assets; if prolonged, it amounts to balance sheet insolvency.
As such, many investors view companies with negative shareholders’ equity as risky or unsafe. However, shareholders’ equity alone is not a definitive indicator of a company’s financial health; however, used in conjunction with other tools and metrics, an investor can accurately analyze the health of an organization.
All the statistics required to compute shareholders’ equity is available on a company’s balance sheet. Total assets include current and non-current assets. Current assets are assets that can be converted to cash within a year (e.g., cash, accounts receivable, inventory). Long-term assets are assets that cannot be converted to cash or consumed within a year (e.g. investments; property, plant, and equipment; and intangibles, such as patents).
Total liabilities consist of current and long-term liabilities. Current liabilities are debts typically due for repayment within one year (e.g. accounts payable and taxes payable). Long-term liabilities are obligations that are due for repayment in periods longer than one year (e.g., bonds payable, leases, and pension obligations). Upon calculating the total assets and liabilities, shareholders’ equity can be determined.
Market analysts and investors prefer a balance between the amount of retained earnings that a company pays out to investors in the form of dividends and the amount retained to reinvest back into the company.
Shareholders’ equity is an essential metric to consider when determining the return being generated versus the total amount invested by equity investors. For example, ratios like return on equity (ROE), which is the result of a company’s net income divided by shareholders’ equity, is used to measure how well a company’s management is using its equity from investors to generate profit.