Shareholders' equity measures the collective value of company shares. The statement of changes in shareholders' equity along with the balance sheet, the income statement and the cash flow statement make up a corporate financial statement. Shareholder equity is constantly changing and is affected by the retention of earnings, the issuance of shares, the creation of treasury shares and the distribution of dividends.
Retained earnings are any company's earnings that are not distributed to shareholders as dividends. If the company loses money, the amount of the loss is referred to as retained losses. Retained earnings and losses are cumulative -- if a new company retains $30,000 in earnings in 2010 and another $50,000 in 2011, its retained earnings will be reported as $80,000 on the 2011 company balance sheet and the statement of changes in shareholders' equity. In this example, the retained earnings component of shareholders' equity has increased by $50,000 in 2011.
When a company offers shares to private investors or the general public, it sells ownership stakes in the company. The corresponding increase in company funds due to the sale of shares results in an increase in shareholders' equity. However, the equity stake of individual shareholders is diluted unless they purchase shares during the share offering. Although a public share offering may result in changes in the market price of a company's shares, this does not affect the amount of shareholder equity -- it represents an unrealized capital gain or loss for shareholders..
Treasury shares are shares owned by the company itself. They are created when a company buys back some of its own shares from its shareholders. The creation of treasury shares reduces shareholder equity by the amount the company pays for them. Companies buy back their own shares when they believe their shares are undervalued by the market. By reducing the supply of shares, they hope the market price for them increases.
Dividends are distributions of company assets to shareholders. A company may release cash dividends, or it may issue shares as dividends. Cash dividends reduce shareholder equity, while share dividends do not. Although the equity value of each share drops slightly as a result of the distribution, the increase in the number of outstanding shares compensates for this drop.
- Stockbyte/Stockbyte/Getty Images