Michael is a financial planner and has a master's degree in financial services.
This lesson will provide an overview of stockholders' equity. Whether you invest in a company now or intend to in the future, you are likely to come across stockholders' equity at some point, so this lesson will define the term and provide the formula for your reference.
Overview of Stockholders' Equity
Maggie Moneybags just retrieved her mail from the post office and found a letter she's been waiting for -- her first retirement plan statement has arrived! You see, Maggie just recently started contributing to her retirement plan at work. The people who run the plan let her pick how she wants her retirement money invested.
Just this past month, Maggie's employer withheld $100 from Maggie's paycheck and put it into her retirement account. She decided to invest it in ABC Mutual Fund, and her statement shows the top five stocks in which ABC Mutual Fund has invested her money. Maggie is most interested in the top holding, a company called MNO Corporation. Since Maggie now owns part of this company, she wants to know more about it!
Definition of Stockholders' Equity
Maggie goes to her favorite search engine, Yagoog, and types in MNO Corporation. She is directed to the finance section of Yagoog, where she goes to the financial section of the company. She finds a balance sheet. How does Maggie know how to do this? She keeps her personal finances on a net worth statement and knows that a company's balance sheet is its version of a net worth statement. Since she wants to know what the company owns and what it owes, she looks at the balance sheet.
On that balance sheet, she sees three headings: assets, liabilities, and stockholders' equity. What is actually owned by the company (and its investors, like Maggie) is the difference between the assets and liabilities, or the stockholders' equity.
Keep in mind that assets are things the company owns and liabilities are what is owed, like loans. Stockholders' equity includes things like what the investors gave the company to start it in exchange for stock (paid-in capital), any donated money or other assets, and the earnings the company has kept for itself and not paid back to its investors as a dividend (retained earnings).
Formula for Stockholders' Equity
Whew! That was a lot of terms in a very short amount of time. Let's put some of the terms in action by going over the formula for stockholders' equity. Let's check in on Maggie and see what she finds out.
Maggie is staring at her computer screen and MNO Corporation's balance sheet. Her screen shows:
Stockholders' Equity: $13,000,000
Maggie notices that if she subtracts liabilities from assets, she gets the stockholders' equity number. Could this be right? Yes!
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That is the very formula for stockholders' equity.
Assets - Liabilities = Stockholders' Equity
Simply put, the stockholders' equity is what the company owns minus what it owes. Maggie now knows that she bought stock of a company that has total stockholders' equity of $13 million.
Stockholders' equity can vary frequently. For instance, when a company issues a dividend, the stockholders' equity may decrease. On the flip side, if the company adds to retained earnings because it made money, stockholders' equity may increase. She will check this again next quarter to track the company's performance.
Maggie Moneybags has completed her quest in locating the stockholders' equity of MNO Corporation. She learned that what is actually owned by the company is the difference between the assets and liabilities, or the stockholders' equity. She now knows that the formula for stockholders' equity is:
Assets - Liabilities = Stockholders' Equity.
Stockholders' equity is comprised of things like what the investors gave the company to start it in exchange for their stock, called paid-in capital; any donated money or other assets; and the earnings the company has kept for itself and not paid back to its investors as a dividend, called retained earnings.
The formula for stockholders' equity is actually quite simple; it's basically what the company owns minus what it owes, or in formula form:
Assets - Liabilities = Stockholders' equity
Now that Maggie has a good idea of the definition of stockholders' equity and the formula, she wants to explore the other stocks held in her mutual fund in her retirement plan. She can't wait until she gets her next statement in the mail!
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