Stockholders' Equity

Stockholders' equity is the amount of a corporation's assets that belongs to its owners once all of its liabilities have been subtracted. It is the third section of the balance sheet, after assets and liabilities, and represents the shareholders' residual interest in the business. The same figure is called shareholders' equity, especially outside the United States, owners' equity in unincorporated businesses, and net assets or book value in general usage.

Equity comes from two main sources: money and other assets that shareholders have invested in exchange for shares, and profits that the company has earned and kept rather than paid out as dividends. Losses, dividends and share buybacks reduce it. Because equity is a balancing figure based mostly on historical cost accounting, it usually differs, often greatly, from the market value of the company's shares.

Stockholders' equity follows directly from the accounting equation:

Here $\text{Total assets}$ is everything the company owns or controls that has measurable value and $\text{Total liabilities}$ is everything it owes to lenders, suppliers, employees, tax authorities and others. If liabilities exceed assets, equity is negative, a situation described as negative equity or a stockholders' deficit.

• Contributed capital: preferred stock and common stock, recorded at par or stated value, plus additional paid-in capital, the amount received above par. Some states define part of this as legal capital that cannot be distributed.
• Retained earnings: cumulative net income less dividends declared, or an accumulated deficit if losses have exceeded profits.
• Accumulated other comprehensive income: gains and losses that bypass the income statement, such as foreign currency translation adjustments and certain pension and investment items.
• Treasury stock: the cost of shares the company has repurchased and not cancelled, shown as a deduction.
• Noncontrolling interest: in consolidated statements, the share of subsidiaries' equity owned by outside investors.

A company's balance sheet shows total assets of $48 million and total liabilities of $30 million, so stockholders' equity is $18 million. Its equity section reads:

With 4,800,000 shares outstanding, book value per share is $18,000,000 divided by 4,800,000, or $3.75. If the shares trade at $9, the market values the company at 2.4 times book value. If net income for the year was $2.7 million, return on equity is 15 percent on year-end equity.

Lenders treat equity as a cushion that absorbs losses before creditors are affected, so they watch measures such as the debt-to-equity ratio and often set minimum net worth covenants. Investors use return on equity to judge how well management uses shareholders' capital, and the price-to-book ratio to compare market value with book value. Changes during the year are explained in the statement of stockholders' equity. Equity has limits as a measure of value: internally created assets such as brands and research are mostly not recorded, buybacks can shrink equity even in healthy companies, and many assets are carried at historical cost. Analysts therefore read it alongside cash flows and market data rather than as a statement of what the company is worth.