Does a Cash Purchase Affect a Stockholder's Equity?

by Jack Ori

When investors purchase stock in a corporation, they become part-owners of that corporation. The amount their stock is worth is called stockholder's equity. Stockholder's equity is affected by the business' financial health, which affects the worth of each share of stock. However, cash purchases by the company do not affect stockholder's equity, because they create an equal liability to the investor's newly purchased asset.

Ownership

Owning stock in a company means you own part of the company. Thus, stockholder's equity is affected by any transactions on the company's part that would affect owner's equity in the company. For example, purchasing assets might affect stockholder's equity as it affects the company's liabilities and assets. However, using cash to purchase assets does not affect equity, because the increase in assets is offset by the increase in liabilities caused by the purchase price.

Equity Formula

Most accountants determine owner's equity by using the formula "owner's equity = assets - liabilities." The accountant adds all of the business' assets, and subtracts all of the business' liabilities, to determine the owner's equity in the business. If the company sells stock, the accountant divides the owner's equity by the total numbers of shares of stock to determine how much equity each share represents. Investors can then multiply the shareholder's equity by the number of shares they own to determine their stockholder's equity.

Asset Offset

When a company uses cash to purchase a new asset, its total assets go up. So it might seem that the cash purchase would make equity higher and thus affect stockholder's equity. However, the purchase price is a liability, so the company's equity remains exactly what it was before the purchase. For example, if a company purchases new equipment for $1,000, assets go up by $1,000, but so do liabilities.

Capital

Capital -- the amount of money invested in a company -- is the only factor that can affect shareholder's equity, as investments affect assets without creating a matching liability. If more investors purchase stock, the company's capital goes up, and stockholder's equity may go up slightly as a result. When the company pays dividends to stockholders, the capital in the company goes down, and therefore stockholder's equity in the company goes down slightly.

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