Stockholders' equity is an essential component of accounting. Companies report stockholders' equity on balance sheets alongside assets and liabilities. The stockholders' equity section of a balance sheet is made up of accounts ultimately representing the value of stockholders' ownership interests in the company. Understanding what makes up stockholders' equity is key to understanding a corporate balance sheet.
Outstanding common and preferred shares of stock make up a large portion of most corporate balance sheets. Corporations list the par value of each type of stock outstanding separately, as well as any paid-in capital in excess of par value. Adding both of the par-value and paid-in-capital accounts reveals the total monetary value of all outstanding stock.
Companies can buy back outstanding shares and hold them for resale in the future. Companies buy back stock to influence stock ratios dependent on the number of shares outstanding, such as earnings-per-share. The treasury stock account lists the value of stock the company is temporarily holding. If a company chooses to retire shares of stock they hold, the balance would not remain in the treasury stock account, and the company would have to issue a round of new stock to boost the outstanding shares figure in the future.
Retained earnings is money that a company sets aside for future use, rather than investing it back into the business or paying it out as dividends in the current period. Retained earnings can be a sign of a strong cash position, which may put some investors at ease. Other investors may view retained earnings as an unproductive use of cash.
Dividends provide a way for shareholders to reap direct financial rewards from the companies they own. Dividends belong in the stockholders' equity section of a balance sheet because they represent the simplest and most direct way for owners to take personal profits. Large dividend payouts can attract certain investors, while driving others away. Investors looking to reap trading profits on the stock market generally prefer to see profits re-invested for company growth, although even high-risk traders can hold a few dividend-paying stocks to diversify their risks.
Owners' equity is the private company counterpart of stockholders' equity. Private companies such as sole proprietorships, partnerships and limited liability company (LLCs) do not sell shares of stock or pay out dividends. Sole proprietorships can get away with including a single account, called proprietors' capital, to present the amount of cash the company has available for personal withdrawal. LLCs include accounts for members' contributions, and draws to account for money put into and taken out of the company by LLC members.
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