The importance of a statement of shareholders’ equity for companies

By Kishana Citadelle
Published: 11/12/21
definition backgroundThe importance of a statement of shareholders’ equity for companies

The importance of statement of shareholders equity simply lies in the fact that it allows companies to see how they’ve been managing their finances quarterly or within an accounting year, also giving them the opportunity to prove whether they are eligible for additional investor.

They can directly see, on their balance sheet, if their numbers are on the right track.

What is a statement of shareholder's equity?

A statement of shareholder’s equity is a financial document, which represents the value, worth of a company once their debts have been paid and their liabilities being taken care of. As shareholders also have a share in the success of a company, it represents the business success as well as theirs. It is the return received by the stockholders versus the money invested.

In addition, it gives them a visual representation of how the company is doing, the changes incurred over an accounting period and can be found in a section of the balance sheet. Of course, one must not forget that, it is essential to provide additional information if any changes present themselves in other equity accounts.

What is included in shareholder’s equity?

There are several components in the shareholder’s equity, and they are:

Share capital

Share capital is the amount of money invested in a company by shareholders to grow the company. It can either be represented by common or preferred stocks or shares.

Preferred stocks, also known as preferred shares, are the stock shares paid in dividend to the shareholders. As they are preferred, it usually means that they have a seniority claim to the payment, earning and assets, that is to say, that they are center stage, to be paid before the common stockholders in case of a liquidation, paying equity. The downside of this type of equity is that they do not have a say in any decisions taken by the company.

Common stocks, though they may be more a part of the decision process, such as the election of the board of directors in the company, they are paid after the preferred stockholders, creditors in terms of liquidation.

Retained earnings

When a shareholder invests in a company, they hold a percentage of the company’s profits, and are entitled, to be paid their dividends.

So, retained earnings are the amount of money the company has earned minus the dividends owed to the investors. If is value is high, then that means that the company’s finances are on the right track and is to be calculated as such:

Beginning retained earnings + Profits/losses - Dividends = Ending retained earnings

It is reserved for reinvestment, for the purpose of capital, capital expenditure and debts.

Net income

It is a company gross income minus the expenses and costs, like debt, taxes, and operating expenses and more. Simply, it is the money left after your expenses are subtracted from the total profit.

You can calculate it, using this formula:

Net income = Total Revenue - Total Expenses

Dividends

They are the funds paid to the shareholders. It is the sum of money paid per share of stock.

There are different types of dividends:

  • Cash dividend: The stockholder is directly paid in cash. Though, in some cases, it can be through wire transfer.
  • Stock dividend: Investors are paid with extra stock shares or when new stocks are issued.
  • Dividend reinvestment programs (DRIPs): It is the dividends, investors choose to give back, reinvest back to the company
  • Special dividends: Rather than pay quarterly or annually, the dividend, having no immediate need, accumulates and is paid out afterwards.
  • Preferred dividends (as mentioned above), they are paid to the senior claim shareholders, unlike the common shareholders and are mostly fixed.

Why is a statement of shareholder equity important?

Firstly, it enables shareholders to see the success of a company they have invested in and decide whether they should make more investments or not and of the future proceedings of the shares.

It aids in:

  • Financial decision-making: It lets company owners know when and how or how much money or not to spend, i.e, borrowing more money for the business’ expansion, reduce cost or more. And leads to your company’s piquing the interest of investors.
  • How the company is running: Shareholders can see if the owner is properly running their business. If they see that equity has declined, then it is proof that something is wrong.
  • Manage financial issues: To know if you are in any financial position to make any decisions at all. It is quite indispensable to know if you need a loan from the bank, if you have to sell your business or if investors should pursue their deal with you.

How to calculate a shareholder equity?

The assets represent current and non-current liabilities.

The liabilities represent short and long-term liabilities. Short term for the debts that are owed within the year and the long term for the debt that can gradually be paid.

To calculate your equity, you must gather the total of assets you possess for the current accounting period on the balance sheet, then take into account the amount of your liabilities you’ve gained and finally subtract it from the assets.

And there you have your shareholder’s equity.

Shareholder Equity = Total Assets – Total Liabilities

There is also another formula, which can help you calculate the equity as well, and it is:

Shareholders’ Equity = Share Capital + Retained Earnings – Treasury Shares

This formula takes into consideration the capital that was paid for shares, added to the retained earnings minus the treasury shares, which the company had previously issued, but repurchased.

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