Revenue is strongly linked to stockholder equity. However, there are other things to consider when studying the relationship between stockholder equity and revenue. As is often the case, one must take a closer look at a company’s finances to understand how changes in revenue impact stockholder equity.
Defining Stockholder Equity
One common definition of stockholder equity is contributed capital plus retained earnings. Contributed capital comes from the investors who purchase stock in a company and retained earnings are earnings that a company may reinvest in itself. Therefore, stockholder equity is dependent on other factors and will change in accordance with changes in these underlying factors.
Effect of Revenue
Revenue is the amount of gross income a company generates over a given time period. As a portion of revenue translates into retained earnings, revenue has the potential to increase stockholder equity. It is important to note that the amount of revenue a company is able to keep as retained earnings varies depending on the situation, so a certain revenue number does not guarantee a specific increase in stockholder equity.
The biggest factor impacting revenue and stockholder equity is cost. The more costs a company incurs when attempting to increase revenues, the smaller the retained earnings. Therefore, higher costs limit increases in stockholder equity even in cases where revenue increases. Over the long term, the company’s business strategy also has a significant impact. If a company allocates capital efficiently, this ultimately has a positive effect on earnings and stockholder equity.
Ultimately, revenue has the potential to increase stockholder equity, but there is not a direct relationship between the two. Costs determine how much revenue the company retains and this in turn effects stockholder equity. In a long term perspective, the efficiency with which a company allocates capital affects stockholder equity because it strongly influences future profit potential for the company.