Stockholders’ equity is a key financial metric for investors and analysts. It is used to evaluate the overall worth of a company and informs decisions on whether to invest in, hold, or sell the stock. In this article, we will provide a step-by-step guide on how to calculate stockholders’ equity.

What is Stockholders’ Equity?

Stockholders’ equity, also known as shareholders’ equity or owner’s equity, represents the residual interest of the company’s owners after all liabilities have been deducted from its assets. In other words, it measures the net worth of a company attributable to its stockholders.

Formula for Calculating Stockholders’ Equity

The basic formula for calculating stockholders’ equity can be expressed as follows:

Stockholders’ Equity = Total Assets – Total Liabilities

However, in practice, stockholders’ equity is often broken down into several components to provide a more detailed view of a company’s financial position:

Stockholders’ Equity = Common Stock + Preferred Stock + Retained Earnings – Treasury Stock

Let’s discuss each component in detail.

1. Common Stock: This represents the total value of shares issued and outstanding that offer only basic ownership privileges, such as voting rights and dividend claims. It is calculated by multiplying the number of outstanding shares by their par (or face) value.

2. Preferred Stock: This component includes the total value of shares issued and outstanding that offer preferential ownership privileges over common stock, such as priority dividend payments and higher claims in case of liquidation. Like common stock, it is calculated by multiplying the number of preferred shares outstanding by their par value.

3. Retained Earnings: These are the cumulative profits retained in the business since its inception after paying out dividends to stockholders. Retained earnings may be positive or negative depending on the company’s profitability over time.

4. Treasury Stock: This refers to the shares bought back by the company itself. Companies repurchase their shares in the open market to increase earnings per share or to reduce the number of outstanding shares. The cost of these shares gets deducted from stockholders’ equity, as they are no longer counted as equity.

Step-by-Step Guide to Calculating Stockholders’ Equity

Follow these steps to calculate stockholders’ equity:

1. Gather all the financial statement data you need for each component of stockholders’ equity, including information on common and preferred stock outstanding, retained earnings, and treasury stock.

2. Calculate common stock by multiplying the number of outstanding common shares by their par value.

3. Calculate preferred stock by multiplying the number of outstanding preferred shares by their par value.

4. Add common stock and preferred stock together.

5. Add retained earnings to the sum obtained in step 4.

6. Subtract the cost of treasury stock from the sum obtained in step 5.

7. The result is your calculated stockholders’ equity.

Conclusion

Calculating stockholders’ equity is essential for investors and analysts looking to evaluate a company’s financial health and investment prospects. Understanding each component of this metric enables users to make informed decisions about whether to invest in, hold or sell a company’s stock. Keep this guide handy next time you plan on evaluating a company’s balance sheet.