Corporations fund themselves in three primary ways -- by selling shares to shareholders, by earning money through business operations and by borrowing money. Shareholder's equity represents an ownership interest in the company. If the corporation has issued more than one class of stock, common shareholders' equity is that portion of total shareholders' equity represented by the common shares.
A corporation's total equity is represented by the amount paid in by shareholders when they bought their shares, the net value of company property, such as equipment, and any retained earnings generated by business operations. It is not discounted by any debt the corporation may be carrying. Total equity is used to calculate a corporation's debt/equity ratio, one of the primary metrics used to determine corporate financial health. Generally, a low debt/equity ratio is considered healthier than a high one.
Common Shares vs. Preferred Shares
The equity of common shareholders includes voting rights, while the equity held by preferred shareholders frequently does not. If the corporation dissolves, it must pay its debts before distributing any remaining equity to shareholders. Preferred shareholders have priority over common shareholders when remaining assets are distributed to shareholders upon dissolution. Depending on the terms of the share subscription agreement, they may have priority over common shareholders in the distribution of dividends.
Common Shareholders' Equity
A shareholder enjoys fractional ownership of a corporation in proportion to his equity stake, represented by the number of shares he holds in proportion to the total number of shares issued to all shareholders. A shareholder's fractional ownership is diluted whenever the corporation issues new shares. According to J. David Spiceland, author of "Intermediate Accounting," common shareholder's equity is calculated by subtracting the amount of equity represented by preferred shares from the company's total equity.
Common shareholders' equity is often used to calculate the return on equity for the preparation of financial statements. The return on common shareholders' equity is a measure of how well the company uses the funds invested by common shareholders to generate a profit. It is calculated by dividing the corporation's net income after taxes by common shareholders' equity. A high value indicates that the corporation has been using this equity efficiently.
- Cliffs Notes: The Balance Sheet: Stockholders' Equity
- "Intermediate Accounting"; J. David Spiceland; 2007
- Stanford University; Cardinal Money Management; Market Cap
- Financial Times Lexicon: Return on Equity ROE
- Jupiterimages/Pixland/Getty Images