Stockholders' equity constitutes one of the most important facets of corporate finance and capital structure, or the financial makeup of a company with regards to stock and debt. When accountants create financial records for publicly traded corporations, stockholder equity comprises one of the most important and prominent elements of these books and includes a variety of items. Items included in stockholders' equity include both theoretical and actual elements and run a wide gamut.
Stockholder Equity Basics
Simply defined, stockholders' equity constitutes everything to which stockholders hold claim, or the value of the company that belongs to the shareholders. The basic equation for calculating stockholder equity is: stockholders' equity equals assets minus liabilities. Assets constitute everything of value a company owns, while liabilities constitute all outstanding debts. Liabilities include loans and other outstanding obligations, as well as bonds, or debts sold as securities. Corporate structure works such that shareholders hold no liability when it comes corporate debt.
Theoretically speaking, every item a company owns minus the amount of its debts belongs to stockholders, thereby comprising a form of stockholders' equity. However, this equation only considers the abstract value of assets, not the assets themselves. If a company goes bankrupt, shareholders don’t actually assume possession of things like heavy machinery. Rather, the company liquidates all assets and uses proceeds from the liquidation to pay off debts and repay shareholders. Therefore, while all of a company’s assets may theoretically qualify as shareholders' equity in some way, only the cash value of these items actually comprises shareholders' equity.
Elements of Stockholders' Equity
Two elements of stockholders' equity exist, contributed capital and retained earnings. Contributed capital constitutes the amount of money invested in a company by stockholders. Retained earnings constitute capital earned by a company that it reinvests in business operations to grow the business. For instance, assume you start a company and sell 1,000,000 shares of stock for $20 each. With this sale, you generate $20,000,000 in contributed capital. Then assume you use that $20,000,000 to generate $50,000,000 in profit, of which you pay $10,000,000 in dividends and reinvest $40,000,000 in the company for continued growth. That $40,000,000 constitutes retained earnings, and it belongs to the shareholders as a form of stockholders' equity.
Shareholders' Equity Items
Three types of shares make up stockholders' equity: common stock, preferred stock and treasury stock. Preferred stock holders receive preferential treatment with regards to dividends and assets in the case of liquidation, though hold no voting rights and must sell their shares back to the company upon maturation, like a bond. Common stock holders receive secondary treatment with regards to dividends and liquidation though hold voting rights and can sell shares whenever they please. Sometimes, different classes of common stock, such as Class A and Class B, exist. Treasury stock constitutes stock the company itself owns, meaning the company constitutes one of its own shareholders and therefore holds rights to a portion of stockholders' equity.
- Accounting Coach; Stockholders’ Equity; Harold Averkamp
- Cliff Notes: The Balance Sheet -- Stockholders' Equity
- “Financial and Managerial Accounting”; Belverd E. Needles et al; 2011
- Principles of Accounting; Corporate Equity Financing; Larry Walther
- Business Dictionary: Shareholders' Equity