Shareholder’s equity is also termed as shareholder’s fund. This is because the company’s net worth would be given back to the shareholders in company liquidation after paying off the debts. Generally, shareholders fund is the excess of assets over liabilities. Also, it could be seen as the investment of shareholders in the company, i.e., the share capital and all the company’s retained profits. Two types of stocks are sold by companies: preferred and common. Preferred shareholders are entitled to dividends while common shareholders enjoy both voting rights and dividends with the remaining earnings after respective payments have been made.
Understanding Shareholders’ Funds
Generally, shareholder funds are excess assets over liabilities. However, this may not be the case every time, meaning it could be negative. When the shareholder’s equity is positive, the value of assets exceeds the value of liabilities. In other words, the company has enough assets to meet liabilities. Conversely, a negative shareholder’s equity means that there will be nothing left for the shareholders after paying off the debts.
Investors are very cautious of negative shareholder’s equity because it means that investing money in such companies would be risky. Also, it is possible that shareholders might not get anything in return. When the condition of negative shareholder’s equity arises, all the liquidated assets are insufficient to pay off all debt.
Shareholder fund is another term for owners’ or shareholder’s equity. It signifies the funds invested in the company through stock purchases or any other private investments. Companies usually report this figure on the balance sheet, with shareholder funds essential in accounting.
For example, companies could sell two types of stock that represent shareholder’s equity: preferred and common. Preferred shareholders receive dividends while common shareholders have voting rights.
How to Calculate a Shareholder’s Fund?
Shareholder’s Fund = Total Assets-Total Liabilities
The above formula is called the basic accounting equation. Add all assets and subtract all liabilities in the balance sheet. Total assets are the full value of short-term and long-term assets. Total liabilities are attained by adding current and long-term liabilities.
Components of Shareholder’s Equity
To calculate shareholder’s funds, it is required to know the components of shareholder’s funds. The components are:
Share Capital
A company’s money by issuing ordinary or preferred shares is known as share capital. It is reported in the equity shareholder’s section on the balance sheet.
- The outstanding share capital: The outstanding share capital represents the capital raised by issuing shares. If a company issues 10000 shares of Rs.10, then the value of outstanding share capital would be 1 lakh. While calculating the outstanding share capital, we need to consider the share’s book value and not the market value.
- Additional paid-in capital: when a company issues a share at a premium, the difference between the par value and the market value at which the share was subscribed is known as additional paid-in capital. E.g., if a company issues 10000 shares with a book value of Rs.10 at Rs.12, the additional paid-in capital would be Rs.2*10000= Rs.20000.
Retained Earnings
After earning profits from business operations, a company retains a part of the profit to keep it for future growth and expansion; it is called retained earnings. After that, the leftover profits are distributed among the company’s shareholders. For example, a company makes a profit of 10 lakh but distributes only 6 lakh among the shareholders as dividends. The remaining 4 lakh is the retained earnings of the company. When calculating shareholder’s equity, retained earnings are added to share capital as they are part of the shareholder’s fund.
Reserves and Surplus
Reserves and surplus are the amounts taken out from retained earnings and are put aside for specific purposes such as buying fixed assets, payment of debts, etc. When a company carries out its operations for some time, it encounters some unknown expenses, and to counter those expenses, it makes these reserves. These reserves are made so that the company’s financial position is not affected by any expenses.
Conclusion
Shareholder funds are used to assess the company’s worth and long-term sustainability. It tells the investors if it is profitable for them to invest in the company and is also an important source of valuation. It is important to decide if it is safe to invest in a company. However, there are many other methods to evaluate the company’s financial health. When a company fails to pay its shareholders, it negatively impacts investors and creditors.
