We have come to our last article Analysing Financial Statements. Today we will be looking Equity. A simple definition of equity would be the value of the asset after the liabilities or debts have been paid. Equity can also be the stock you own in the business. This is called shareholders’ equity. These stocks represent an ownership in a business. It is the measure of the company’s net worth.
A simple example to explain equity.
Joe opens a small bakery. He borrows $10,000 loan from the bank for the building and supplies. The business becomes a very successful bakery. With his success, he paid for all the supplies and $5000 on the loan of the building. Joe has acquired $5000 on equity. If he is able to pay the balance of the loan, his equity will increase. His equity also increases when the price of property of the building increases.
Shareholders’ equity is accounted for under the headings of Common Stock, which includes Preferred stock and Common stock;Paid up capital, Retained Earnings. The retained earnings account keeps track of all the company’s earnings and all the dividends paid to the owners (shareholders) over the years of the corporation’s life. The shares account show the investments made by owners (shareholders) into the company. A graphical view of a typical corporation’s equity section would be;
|Paid up capital||
|Total Shareholders’ Equity||
If, at the end of the fiscal year, a company decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from the income statement onto the balance sheet and into the shareholder’s equity account. This account represents a company’s total net worth. In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus shareholders’ equity on the other.
Why Shareholders’ Equity is an important number
- It allows us to calculate the return on shareholders’ equity which is one of the ways we determine whether or not the company in question has long-term competitive advantage working in its favour.
- it shows the management’s efficiency in allocating the shareholders’ money.
- High returns on equity means th Thank at the company is making good use of the earnings that it is retaining. As time goes by these high returns on equity will add and increase the underlying value of the business, which over time, will eventually be recognized by the stock market through an increasing price for the company stock.
This concludes our series of articles on analysing financial statements .
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