When a company earns a profit, you’d expect to see an increase in its equity. However, the gross increase in stockholders’ equity is not always the same as the firm’s profits because some of the earnings may be distributed as dividends. In addition, there are other reasons for stockholders’ equity to increase that investors should be aware of.
It is easy to find out how much stockholders’ equity a company has accumulated. All you do is look on the company’s balance sheet. Stockholders’ equity is listed last and is always equal to the total assets minus total liabilities. To see how much stockholders’ equity has increased, subtract the stockholders’ equity on the previous year’s balance sheet from the current figure. If you want to know how much of the gross increase in stockholders’ equity is attributable to business activity, you have to dig a little deeper. The company’s income statement provides the details of a company’s earnings from business activities, which are also called operating activities. You’ll also need the statement of shareholders’ equity, which gives you a breakdown of changes in equity. All of these documents are available in a company’s annual report.
The increase in stockholders’ equity attributable to business activities is a portion of the company’s net income. Accountants figure net income on the company’s income statement. A firm’s revenues are listed first. Expenses are subtracted from revenue. Expenses include the cost of goods sold, operating expenses, depreciation, interest and taxes. Whatever is left over is the company’s net income, or profit. If the bottom line is a negative number, the company suffered an operating loss for the period.
On the company’s statement of shareholders’ equity, the total equity from the previous year is listed first. Next, the capital raised from sale of common and preferred shares is listed, followed by the amount raised form the sale of new shares of common and preferred stock. The net income from the income statement is listed and the amount of any dividends paid to stockholders is subtracted. The difference between net income and dividends paid is called retained earnings. Retained earnings are the increase in stockholders’ equity attributable to business activity.
Changes in Equity
You might want to know what percentage of the increase in stockholders’ equity comes from retained earnings. To calculate this, first subtract the previous year’s stockholders’ equity from the current total. Divide the result into the retained earnings for the year and multiply by 100 to convert to a percentage. Suppose a company started with stockholders’ equity of $2.5 million and finished with total equity of $3.5 million, including $250,000 in retained earnings. The difference in equity is $1.0 million. Divide $1 million into $250,000 and multiply by 100 and you find that 25 percent of the increase in equity is due to earnings from business activities.