The balance sheet refers to a financial statement that communicates the financial worth of the company. This includes assets, liabilities and stockholders’ equity. Stockholders’ equity represents the value of the company which belongs to the stockholders. Investors review the stockholders’ equity section to learn what accounts make up the equity. Investments, dividends, income and stock repurchases impact the total stockholders’ equity balance.
Stockholders’ equity changes when new or current investors contribute more funds to the business. This occurs through the sale of additional shares of stock. When the company decides to issue stock, it requests authorization for a specific number of shares. The company determines this number by considering the number of shares it wants to sell at that time and in the future. It sells some shares and keeps the additional shares until it needs to sell them in the future. This allows investors to purchase shares of the stock and increases the value of stockholders’ equity. Each additional share sold increases the contributed capital and stockholders’ equity by the amount paid for the stock.
When companies issue dividends, the stockholders’ equity decreases. The board of directors declares a dividend at its regular meeting. The board may declare a stock dividend or a cash dividend. Stock dividends issue additional shares of stock to the investors. Cash dividends provide cash payments. The company records a liability to pay the dividends after the board declares the dividend. The dividend liability reduces retained earnings and stockholders’ equity.
Businesses record their revenues and expenses on the income statement and calculate net income. At the end of each period, the company closes out the revenue accounts and the expense accounts to an income summary account. The balance in income summary equals the company’s net income. The company transfers the income summary balance to the retained earnings account. This increases retained earnings and stockholders’ equity.
Some companies purchase their own stock from the stock exchange. Companies use this stock to fulfill stock option obligations, to pay stock bonuses to employees or to reduce the number of shares outstanding. The company reports these shares as treasury stock on the balance sheet. Treasury stock reduces total stockholders’ equity.