A balance sheet, or statement of financial condition, shows the items controlled or owned by a company, the owners' interest in the company and the debts the company owns. The accounting equation assets = liabilities + owner's equity makes it simple to figure out exactly how much the owner's equity is. However, in order to analyze the health of a business, the three parts of total equity -- contributed capital, retained earnings and valuation equity -- must be looked at.
1. Look at the retained earnings figure on the balance sheet. Retained earnings represent how much net income has been earned but not withdrawn by the owners and is perhaps the most important section on the balance sheet for showing company health. The higher the amount of retained earnings, the greater the company's ability to make and retain profits.
2. Find the contributed capital figure on the balance sheet. Contributed capital is how much the owners invested in the company and could arguably be considered retained earnings. This is because that initial investment -- as long as that investment is still in the company -- represents an amount of money that the business could draw on for expansion or is available should the company be sold or liquidated.
3. Look at the valuation equity section on the balance sheet. Valuation equity is the difference between the market value and book value, or cost less accumulated depreciation. This figure -- which can be positive or negative -- gives you an estimate of the market value of company assets relative to how much those assets cost. An increasing valuation equity figure means that the market value of assets is increasing and therefore the owner's equity is increasing.
- Valuation equity is only useful if you know about the market values for the assets in question and the volatility of the market those assets are in. Research your market carefully before coming to a conclusion about how much of a part valuation equity plays in determining the health of any particular company.
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