“I have to look out for the shareholder’s interests, and I’m the largest shareholder.”
Carl Icahn
Ownership of a corporation lies with the shareholders. What is left of cash and assets after subtracting, or discharging, obligations owed to creditors becomes Shareholders Equity.
Shareholders Equity is the balance left after subtracting Assets from Liabilities. This fits into the balanced equation: Shareholders Equity* = Assets – Liabilities.
You will find the shareholders equity line at the bottom of the balance sheet that you typically find in a company’s 10-K filing. You may see shareholders equity as two components:
- Contributed Capital – This includes common stock, paid in capital (the investment made by a stockholder), preferred stock, treasury stock
- Retained Earnings – This is the cumulative net income, not just current period net income, that includes all prior years. These retained earnings can stay on the books for years and accumulate to the benefit of the shareholders as a large amount of their total equity. They can also be used to plow into important functions, like research and development. Finally, they can also be used for a share buyback wherein shares become known as Treasury shares.
Shareholders Equity – commonly known as “book value” – is a strong indicator of a company’s financial health. Small or negative shareholders equity could indicate poor fiscal management or even impending bankruptcy. If a company goes out of business, equity is distributed once all debtors are paid back.
Shareholder Value is the present, discounted worth of current and future free cash flow, which is cash generated by operations minus the required capital investment and debt. Improving shareholder value is a key focus for corporations as they try to put money back into the company to create profitable products and services.
* Shareholders Equity is also referred to as Retained Earnings. Because of this, you may see the balanced equation as ALRE, or Assets = Liabilities + Retained Earnings.
