Shareholders Equity – Toshiba is writing down its investment of $8.3 billion in Nuclear Power Business in US. This will result in wiping out the entire total shareholder’s equity of Toshiba! Obviously this is negative as the share decline led to the erosion of more than $7 billion in market value.
Shareholder’s equity is the interest of shareholders in the net assets of the company. It is one of the most important aspects of the balance sheet. And there are so many components which we need to take into account under shareholders equity.
In this article, we will learn the nitty-gritty of shareholders equity.
- What is Shareholders Equity?
- Components of Shareholders Equity
- Shareholders Equity of Nestle
- Shareholders Equity Calculation Example
- Reasons for Negative Shareholder’s Equity
- Statement of changes in Shareholder’s Equity
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What is Shareholders Equity?
Shareholder’s equity is the interest of shareholders in the net assets of the company. You may wonder why! Here’s why.
The assets of the company are either financed by creditors or brought in by shareholders. Now, the creditors will be entitled to get paid till the extent they have contributed toward financing the assets. And the rest will be enjoyed by the shareholders. Shareholders are valued most because they share both of profits and losses.
Imagine that you invest in business. You would expect a meagre return from the investment (if not more than your opportunity cost). And then business doesn’t yield any profits. Instead, it incurs losses. As a result, you will not get any return. Whenever a shareholder invests into a business, he takes the risk of both – profit and loss. That’s why shareholders are valued most in a business. And that’s the reason maximization of wealth of the shareholders is one of the prime goals of business.
So, going back to our discussion of financing assets, here’s how things work. All the creditors who have invested in the assets are “liabilities” of business, because they need to be paid irrespective of profit or loss of business. So they will be paid first. And then whatever is left remains intact for the shareholders.
Thus, we can express assets in the following manner –
Assets = Liabilities + Shareholders Equity
If we can interchange the equation a bit, we will get the definition of shareholders’ equity formula –
Assets – Liabilities = Shareholders Equity
This residual interest (difference between assets and liabilities) is called “capital” in sole proprietorship business and the same is called “sum of individual capital” in partnership business.
Components of Shareholders Equity
Instead of looking into a formula, we will look at the components of Shareholders Equity which will help us understand what we need to take into account. Below is the snapshot of Amazon’s Shareholder’s Equity of 2015 and 2016
source: Amazon SEC Filings
#1 – Common Stock
Common Stock is the first and most important component of shareholders equity. Common stockholders are the owners of the company. They are the ones who will receive the profits and deal with loses after the company pays interest and dividends to preference shareholders. And they also have voting rights.
Here’s how to calculate common stock –
Common Stock = Number of shares issue * Par value per share
There are two things to consider here – the number of authorized share capital and the number of shares issued. Numbers of authorized share capital represent the numbers of shares the company can issue legally. And the number of share issued means the actual number of shares that the company has issued.
In Amazon, common stock outstanding is $5 million in both 2015 and 2016.
#2 – Additional paid-up capital
Additional means more than the share price. That means when the company receives premium on the shares, we would call it additional paid-up capital. Here’s how to calculate it –
Additional paid-up capital = (Share Price – Par Value) * Number of shares issued
Additional paid up capital for Amazon is $13,394 million and 17,186 million in 2015 and 2016, respectively.
#3 – Preferred Stock
Preferred stockholders are shareholders who have secondary rights in the net assets. They don’t have voting rights but they enjoy a fixed dividend even before anything is given to the common stockholders. Here’s how it is calculated –
Preferred Stock = Number of preferred shares issued * Par Value per share
There are no preferred stock in Amazon.
#4 – Retained Earnings
Retained earnings or losses are accumulated from the previous period. In simple terms, retained earnings are the amount company keeps after paying the dividend from net income. This amount is reinvested in the company. Here’s how we would calculate retained earnings for the end of the period –
| Particulars | |
| Retained Earnings at the beginning | *** |
| (+) Net Income for the year | ** |
| (-) Dividend paid | ** |
| (+/-) Any change in accounting policy | * |
| Retained Earnings at the ending | *** |
Retained Earnings for Amazon is $2,545 million and 4,916 million in 2015 and 2016, respectively.
#5 – Treasury shares
Treasury shares is the sum total of all the common shares that have been purchased back by the company. Thus, treasury shares are the opposite of common equity shares. Common stock has a credit balance; whereas treasury shares have debit balance. That’s why all treasury shares are required to deduct from all equity components.Treasury Stock for Amazon is -$1,837 million for both 2015 and 2016.
#6 – Accumulated Other Comprehensive Income
Accumulated Other comprehensive income contains unrealized gains/losses that do not flow through the income statement. Examples are unrealized gains or losses from investments classified as available for sale, foreign currency translation gain/losses, pension plan gains/losses etc.
Accumulated Other Comprehensive Income for Amazon is -$723 million and -$985 million in 2015 and 2016, respectively.
#7 – Minority interest
This is an important part of shareholders equity. They have a minority stake in the company and no controlling power in the company like common stockholders. Minority shareholders are equity attributed to owners who are not of the parent company. Minority interest comes in the consolidated balance sheet. We can compute it in the following way –
Minority Interest = Total shareholders equity – Shareholders Equity attributed to parent
So, now we can have a look at the formula of shareholders equity –
| Shareholders Equity | |
| Paid-in Capital: | |
| Common Stock | *** |
| Preferred Stock | *** |
| Additional Paid-up Capital: | |
| Common Stock | ** |
| Preferred Stock | ** |
| Retained Earnings | *** |
| (-) Treasury Shares | (**) |
| (-) Translation Reserve | (**) |
| Minority Interest | *** |
There is no minority interest in Amazon.
Shareholders Equity of Nestle
Let’s look at a practical example so that we can look at how to look at shareholders equity from a balance sheet.
We will take Nestle’s example.
| Equity | ||
| Share Capital | 319 | 322 |
| Treasury shares | (7489) | (3918) |
| Translation reserve | (21129) | (17255) |
| Retained Earnings & other reserves | 90637 | 90981 |
| Total equity attributable to shareholders of the parent | 62338 | 70130 |
| Non-controlling interest | 1648 | 1754 |
| Total Equity | 63986 | 71884 |
| Total liabilities and equity | 123992 | 133450 |
source: Nestle 2015 Financial Statements
We note that Shareholder’s Equity of Nestle is 63,986 million CHF and 133,450 million CHF in 2015 and 2014, respectively.
Please note that red highlighted items is what we deduct, i.e. treasury shares and translation reserve.
Once we add share capital and retained earnings and deduct treasury shares and translation reserve, we get the total equity attributable to shareholders of parent company. Also, note that since it is a consolidated balance sheet, we need to take into account the non-controlling interest (minority interest); so we add minority interest to the total equity attributable to shareholders of the parent company. And as a result, we got total shareholder’s equity.
Shareholders Equity Calculation Example
Now let’s look at few examples to understand how shareholders equity should be computed.
Shareholder’s Equity Calculation Example # 1
Mr A has got hold of the balance sheet of Q Company. But while traveling, Mr A lost the last part of the balance sheet. So how would he get to know about shareholders equity?
Here’s the remainder of the document.
Balance Sheet of ABC Company
| 2016 (In US $) | 2015 (In US $) | |
| Assets | ||
| Current Assets | 300,000 | 400,000 |
| Investments | 45,00,000 | 41,00,000 |
| Plant & Machinery | 13,00,000 | 16,00,000 |
| Intangible Assets | 15,000 | 10,000 |
| Total Assets | 61,15,000 | 61,10,000 |
| Liabilities | ||
| Current Liabilities | 200,000 | 2,70,000 |
| Long term Liabilities | 1,15,000 | 1,40,000 |
| Total Liabilities | 3,15,000 | 4,10,000 |
Here the computation is easy. Though we would not be able to get the particulars of each item in shareholders equity; we will be able to find out the total amount.
All Mr A needs to do is to deduct the total liabilities from the total assets.
| 2016 (In US $) | 2015 (In US $) | |
| Total Assets (A) | 61,15,000 | 61,10,000 |
| Total Liabilities (B) | 3,15,000 | 4,10,000 |
| Shareholders Equity (A – B) | 58,00,000 | 57,00,000 |
Mr A later went back to the office, sourced the whole balance sheet and saw the missing part of the balance sheet of Q company –
| Shareholders Equity | ||
| Preferred Stock | 550,000 | 550,000 |
| Common Stock | 50,00,000 | 50,00,000 |
| Retained Earnings | 250,000 | 150,000 |
| Total Shareholders Equity | 58,00,000 | 57,00,000 |
| Total liabilities & Shareholders Equity | 61,15,000 | 61,10,000 |
And he found that his calculation of total shareholders equity was absolutely correct.
Shareholder’s Equity Calculation Example # 2
Mr S has the following information about Company Y –
| Particulars | In US $ |
| Common Stock | 40,00,000 |
| Preferred Stock | 800,000 |
| Retained Earnings | 410,000 |
| Accumulated Comprehensive Income (loss) | (50,000) |
| Treasury Shares | 110,000 |
| Minority Interest | 600,000 |
Compute shareholders equity for Mr S.
Here we have all the information we need. Now we will put the values according to the formula.
| Shareholders Equity | |
| Paid-in Capital: | |
| Common Stock | *** |
| Preferred Stock | *** |
| Additional Paid-up Capital: | |
| Common Stock | ** |
| Preferred Stock | ** |
| Retained Earnings | *** |
| (-) Treasury Shares | (**) |
| (-) Translation Reserve | (**) |
| Minority Interest | *** |
According to the formula, here’s the computation below –
| Particulars | In US $ |
| Common Stock | 40,00,000 |
| Preferred Stock | 800,000 |
| Retained Earnings | 410,000 |
| Accumulated Comprehensive Income (loss) | (50,000) |
| Treasury Shares | (110,000) |
| Minority Interest | 600,000 |
| Shareholders Equity | 56,50,000 |
Shareholder’s Equity Calculation Example # 3
Mr T has the following information about Company W –
| Particulars | In US $ |
| Number of Common Shares | 80,000 |
| Number of Preferred Shares | 20,000 |
| Share Price (Common Shares) | 150 per share |
| Share Price (Preferred Shares) | 130 per share |
| Par Value (Common Shares) | 100 per share |
| Par Value (Preferred Shares) | 100 per share |
| Treasury Shares | 100,000 |
| Minority Interest | 300,000 |
Additional information for retained earnings are also given –
| Particulars | |
| Retained Earnings at the beginning | 200,000 |
| Net Income for the year | 500,000 |
| Dividend paid | 100,000 |
| Amount appreciated due to change in accounting policy | 50,000 |
Compute the shareholder’s equity for Mr T.
Let’s start with the calculation of retained earnings first and then we will look at other items one by one.
| Particulars | |
| Retained Earnings at the beginning | 200,000 |
| (+)Net Income for the year | 500,000 |
| (-)Dividend paid | (100,000) |
| (+)Amount appreciated due to change in accounting policy | 50,000 |
| Retained Earnings at the ending | 650,000 |
Now, we will calculate the common stock.
| Particulars | In US $ |
| Number of Common Shares (A) | 80,000 |
| Par Value (Common Shares) (B) | 100 |
| Common Stock (A * B) | 80,00,000 |
Now, we will calculate the preferred stock.
| Particulars | In US $ |
| Number of Preferred Shares (A) | 20,000 |
| Par Value (Preferred Shares) (B) | 100 |
| Preferred Stock (A * B) | 20,00,000 |
We will look at the additional paid-up capital for common stock and preferred stock one by one.
To calculate the additional paid-up capital, we need to use the following formula –
Additional paid-up capital = (Share Price – Par Value) * Number of shares issued
| Particulars | In US $ |
| Number of Common Shares (A) | 80,000 |
| Share Price (Common Shares) (B) | 150 |
| Par Value (Common Shares) (C) | 100 |
| Difference (B – C) | 50 |
| Additional Paid-up Capital (Common Stock)
[A * (B – C)] |
40,00,000 |
| Particulars | In US $ |
| Number of Preferred Shares (A) | 20,000 |
| Share Price (Preferred Shares) (B) | 130 |
| Par Value (Preferred Shares) (C) | 100 |
| Difference (B – C) | 30 |
| Additional Paid-up Capital (Preferred Stock)
[A * (B – C)] |
600,000 |
Now we have all the information required to compute shareholders equity. Let’s compute it –
| Shareholders Equity | |
| Paid-in Capital: | In US $ |
| Common Stock | 80,00,000 |
| Preferred Stock | 20,00,000 |
| Additional Paid-up Capital: | |
| Common Stock | 40,00,000 |
| Preferred Stock | 600,000 |
| Retained Earnings | 650,000 |
| (-) Treasury Shares | (100,000) |
| Minority Interest | 300,000 |
| Total Shareholders’ Equity | 1,54,50,000 |
Reasons for Negative Shareholder’s Equity
In some of the companies, you will find that Shareholder’s Equity is negative. Why is that so?
There can be many reasons. Some of the important ones are listed below.
#1 – Buyback of Shares
This is one of the most common reasons why Shareholder’s Equity turns negative. If the company buybacks shares, the shareholder’s equity portion gets reduced by that amount.
Please see below a graph depicting Negative Shareholder’s Equity of Philip Morris and Treasury Stock. we note that each year, Philip Morris has bought back shares. In 2016, Philip Morris Treasury Stock stood at $35.49 billion. We note that as the treasury stock increases, shareholder’s Equity reduced each year. currently, Shareholder’s Equity of Philip Morris is at -$12.69 billion.
source: ycharts
#2 – Writedowns
Writedowns could be another reason that can lead to negative shareholders equity. Most recent example is that of Toshiba. Toshiba invested heavily in its US Nuclear Power business and realized that it will not give returns as they expected earlier. They took a write-down of a whopping $8.3 billion in this business. Currently, Toshiba’s shareholder’s equity is at $2.92 billion. With this huge write-down, Toshiba’s shareholder’s equity will turn negative!
source: ycharts
# 3 – Continous Losses
Net losses reported by the company reduces the Retained Earnings and may lead Shareholder’s Equity. However, if the company reports net losses each year, then it will surely lead to Negative Shareholder’s Equity. One such example is that of Sears Holdings. The company has been reporting losses for the past few years. This has resulted in negative retained earnings as well as Negative Shareholder’s Equity.
source: ycharts
Statement of changes in Shareholder’s Equity
Statement of changes in Shareholder’s Equity provides a detailed breakup and explains the changes in Common Stock Shares, Treasury Stock, Additonal Paid-in Capital, Accumulated Other comprehensive income, Retained Earnings etc.
Let us look at Amazon’s Statement of Changes in Shareholder’s Equity.
Let us take an example of Retained Earnings from the above statement and see how it got changed over the years. We note from above that as of the
- As of 1st January 2014, Retained Earnings Balance was $2,190 million
- During 2014, the company reported a net loss of $241 million.
- This resulted in the decrease in Retained Earnings to $1949 million as reported on 31st December 2014.
- This Retained Earnings of $1949 million becomes the starting balance for 2015.
- During 2015, Amazon reported a profit of 596 million, resulting in an increase in Retained earnings to $2,545 million on 31st December 2015.
- In 2015, Amazon reported a profit of $2,371 million, that increased its retained earnings further to $4,916 million.
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