Shareholders' equity, sometimes called stockholders' equity, can increase or decrease based on several of its components, including paid-in capital, net profits for the year and new share offerings. The balance of shareholders' equity is one of a number of balance sheet figures that analysts and investors view when estimating the worth of a company.
What is Shareholders' Equity?
Shareholders' equity is equal to the difference between a company's assets and liabilities. There can be several components to shareholders' equity, including a company's retained earnings, its current profit, funds paid in by the shareholders and capital received from share offerings. Although some investors view shareholders' equity as a representation of the net worth of a company, it does not necessarily provide an accurate valuation. Assets are recorded at their historical -- and sometimes -- depreciated cost, not at what they would be worth if they were sold. The true value of a company is the market value of its assets minus the present value of all of its liabilities.
Capital contributions are funds that shareholders invest in a corporation beyond what they have paid for the shares. If shareholders lend the corporation money to operate or grow, these funds will appear in the capital contributions section. When new contributions are made, the balance of shareholders' equity rises. Funds can be paid to shareholders as a return of the shareholder's capital invested, or as dividends paid out of retained earnings or profits.
Increase in Net Profit
If the corporation makes a net profit in the year, it will appear as an increase in shareholders' equity to the extent that it is not paid out as dividends. Profits in a corporation can be added to the retained earnings of the company in the following year, or they can be paid out to the shareholders as dividends. When a company's retained earnings grow over time, they are viewed by potential investors as a stronger company than one that distributes all profit immediately to its owners. Retained earnings help a company have the funds to grow and prosper.
New Share Offering
If a corporation raises capital through a stock offering, the value of the shares sold minus all investment bank fees and other costs will increase shareholders' equity. This funding represents what is owed to the new shareholders if a company goes out of business. If a company raises money through borrowing, it appears in the liability section rather than the equity section of the balance sheet.
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