Equity essentially represents assets owned by a company that have been purchased without borrowing. Whether you want to invest and buy stock in a company or are about to become an accountant, it is important to know how to calculate it. In accounting, equity represents one third of the basic equation for the double entry method: assets = liabilities + equity. Thanks to this data, investors can quickly calculate the value of a company; for this reason, this equation is an indispensable tool for making a decision about a major investment. Read on to learn the simplest and most effective methods of calculating equity.
Steps
Method 1 of 4: Definitions
Step 1. Before starting to make calculations, it is good to have a clear idea of the basic concepts
Step 2. The capital or net worth (shareholders' equity in English) represents the capital or the own means of a company, therefore it is one of the internal sources of financing
This is the net value owned by the shareholders of a company, ie the value at which each share or stake would be redeemed if the company closed its doors. The net capital is paid by the entrepreneur (in the case of a sole proprietorship), by the shareholders (therefore third party capital) or by means of self-financing (in this case the company reinvests the profits earned during the year to continue with its own activities). It is full risk capital, this means that it is intended exclusively for the company and acts as a guarantee towards third parties.
Step 3. It is calculated as follows: Equity = Total Assets - Total Liabilities
Step 4. In companies, equity is broken down into categories called "ideal portions of equity"
They are:
- Share capital, which represents the value of the shares and shares subscribed. It can be increased or decreased over time. It must be distinguished from the contribution capital (which represents the contribution made by the entrepreneur or shareholders at the time the company is established) and from the savings capital (composed of the profits obtained by the company that are not withdrawn and which remain at the company to finance it).
- Reserves, which can be distributed to shareholders, used to increase capital or as a guarantee of stability of the share capital in the event of losses.
- Profits earned while awaiting destination. They can be distributed to members, invested to increase reserves or used to cover losses.
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Pending losses pending coverage. It is the shareholders who decide how to cover them.
However, this subdivision is not envisaged for sole proprietorships
Step 5. Equity should not be confused with gross equity, also called company equity
Gross capital represents the set of assets and liabilities used by the company for the operation of the same, while the net capital is the difference between assets and liabilities.
Step 6. For shareholders it is possible to know the balance sheet of a company thanks to the financial statements, an accounting document that every company is obliged to draw up regularly
Step 7. Liabilities represent the obligations that a company has assumed towards third parties (such as debts towards banks, suppliers and so on) and the funds of the liabilities
On the other hand, assets include receivables, cash, capital or other goods, and so on.
Step 8. A shareholder or shareholder is the owner of one or more shares of a company
He owns at least one share of a company, so he has the power to enforce the rights that are granted to him by the share or shares purchased. The value of a shareholder is calculated considering the dividends received and the capital gains realized.
A shareholder can be the reference, majority or minority shareholder. A major shareholder is a private individual or company that owns a significant share of shares. Its decision-making power is not determined only by the amount of qualifications held, but also by the skills it has in the management of companies and the sector in which it operates. A majority shareholder has at least 50% + 1 of a company's shares and voting rights, while a minority shareholder owns a lower percentage of shares
Step 9. The rules governing the preparation of the financial statements and the balance sheet are contained in articles 2423 and 2424 of the Civil Code
Method 2 of 4: Sources of Company Financial Statements
Step 1. There are sites that allow you to consult the financial statements of many companies (both large and small), the only drawback is that they are generally paid
Examine the latest balance sheet, at most go back 4-5 years to make comparisons.
Step 2. The Company Register website provides official data from the Chambers of Commerce
The search of the companies is free, while the extraction of the balance is paid. It is possible to obtain information on companies established in Italy and in the participating European countries.
Info Imprese offers a very similar service, called TelemacoPay. Here you will find information on joint stock companies, partnerships and sole proprietorships
Step 3. Company Report shows companies with an annual turnover of more than 5 million euros and offers data of companies located in all Italian provinces
Step 4. If you need the balance sheet of a large company, you can search for it directly on the company website
Just find the section entitled "Financial statements" or "Investors" (or a similar term, often in English, such as "Investors").
Method 3 of 4: Relationship between Assets and Liabilities
Step 1. As explained in the first section of the article, equity is obtained by calculating the difference between assets and liabilities
The result obtained from the subtraction can give rise to several possibilities.
Step 2. Assets = Equity
If the assets and shareholders' equity are equivalent, the company has no debt and the financing takes place using its own resources.
Step 3. Assets> Liabilities
Since assets are calculated by adding liabilities and equity, assets are greater than liabilities, so it follows that equity is given by the difference between assets and liabilities.
Step 4. Assets = Liabilities
In such a situation, the company has no own means.
Step 5. Liabilities> Assets
When the liabilities exceed the assets, it is called a capital deficit.
Step 6. To summarize, the equations to use to make calculations and determine a company's balance sheet are as follows:
- Net assets = Activities - Liabilities.
- Activities = Net assets + Liabilities.
- Liabilities = Activities - Net assets.
Method 4 of 4: Calculation Techniques
Technique of Subtraction
Step 1. Evaluate if you can use this method
To put this into practice you need to know the total assets and liabilities of a company. If you are considering a private company, it will not be easy to obtain this information without being directly involved in corporate management, but you can try to do a search on the sites recommended in the section dedicated to the sources of financial statements. If, on the other hand, it is a company with widespread shareholding, it must regularly publish the economic and financial data and the financial statements.
To find out the data of a company with widespread ownership, do an online search to find the most up-to-date financial document. It should be available on the company's own website
Step 2. Identify the activities of the company
The formula for calculating this figure involves adding fixed assets and current assets. These terms indicate all the properties of the company, from cash to easily recoverable investments, up to the land and means of production.
- Fixed assets include means of production, real estate and fixed assets which are used for more than one year, less depreciation.
- Current assets include receivables from customers, work in progress, inventory or cash in hand. In accounting, this term defines every asset that the company holds for less than 12 months.
- Add the elements of each category (fixed assets and current assets) to obtain the value of each of them and then add the 2 groups together to find the total assets.
- For example, consider a company with fixed assets worth € 1,140,000 (€ 500,000 of buildings, € 400,000 of plant, € 90,000 of furniture, € 70,000 of machinery, € 80,000 of vehicles) and a current assets equal to a value of € 251,900 (€ 130,000 of goods, € 110,000 of customer receivables, € 10,000 of miscellaneous receivables, € 900 of bank deposits and € 1,000 of cash in hand). The total assets will amount to € 1,391,900.
Step 3. Determine the company's total liabilities
Just as with the calculation of assets, the formula for total liabilities is to add the long-term ones to the current ones. Liability means all the money that the company has to pay to creditors to honor bank loans, dividends to investors and bills.
- Long-term liabilities group all debts present in the balance sheet that do not have to be paid within the year.
- Current liabilities are the sum of all outstanding bills, salaries, interest and any other amounts that must be paid within the year.
- First, add up all the items in each category (long-term and current liabilities) to get the total liabilities.
- Suppose that the company in the previous example has current liabilities for a total of € 165,000 (€ 90,000 of invoices to be paid, € 45,000 of partial repayment of a short-term debt, € 10,000 of salaries, € 15,000 of interest expense, € 5,000 of taxes) and € 305,000 of long-term liabilities (€ 100,000 of debt represented by debt securities, € 40,000 of bank loans, € 80,000 of mortgage and € 85,000 of deferred taxes). Add these values together and you get: € 165,000 + € 305,000 = € 470,000. This figure corresponds to the total liabilities of the company.
Step 4. Calculate the net worth
Subtract total liabilities from total assets to find equity. Just rewrite the formula: assets = liabilities + equity, that is equity = assets - liabilities.
If you consider the example analyzed so far, you just need to subtract the total liabilities (€ 470,000) from the total assets (€ 1,391,900) to find the net worth, which is equal to € 921,900
Step 5. The example just illustrated is repeated for a large number of companies
The capital paid in by third parties is only € 470,000, so the company finances almost all investments with its own means (€ 921,900). However, a company can also find itself in other situations:
- An ideal firm would find itself in the following situation: equity equals assets. There are therefore no liabilities and the company finances everything with its own means. However, it is very rare for such a thing to happen.
- When assets are equal to liabilities, anomalies are found. For example, if the total assets (buildings, plants, goods and so on) are equal to € 1,391,900 and the total liabilities (mortgages, debts, and so on) also, the company is in an imbalance. In fact, it does not have its own capital and finances everything with third party means.
- If, on the other hand, the liabilities are greater than the assets, a deficit is created, not to mention that the company does not have its own means. For example, imagine that assets are € 1,391,900 and liabilities are € 1,900,000.
Alternative Technique
Step 1. Evaluate if you can use this method
To apply this technique you must have access to the annual financial statements of the company in question, in particular to the equity section or, alternatively, to the equivalent items in the general accounting sheet. If it is a widely held company, you can find this data on the financial report that the company has to publish online. In other cases, the information can be found on the sites indicated in the section dedicated to the sources of the financial statements, even if it is sometimes difficult to retrieve it without the help of a manager of the company itself.
You can find this data by doing an online search for the most recent financial report. In the case of a company with widespread shareholding, these economic reports are published on the company's website
Step 2. Calculate the share capital of the company
This is the amount of money the company receives from the sale of its shares. The proceeds from the sale of ordinary and preference shares represent the share capital.
- To find this value, you do not have to consider the current market value of the individual stock, but the selling price of the same. This is because the share capital represents the amount of money the company has received from the sales of its shares.
- For example, suppose a company got $ 200,000 from the sale of common stock and $ 100,000 from preferred stock. In this case, the share capital is € 300,000.
- Sometimes this information is reported under items broken down as common, preferred, and share premium reserves. Just add these data together to find the share capital.
Step 3. Check the retained earnings
These are the total profits available to the company after paying dividends and are reinvested in the company itself. In many cases, retained earnings are a much larger portion of equity than the other items.
Retained earnings are typically expressed as a single item in the company's financial report. In the example considered here, assume they are equal to $ 50,000
Step 4. Find the value of the share buyback on the company balance sheet
This represents the treasury shares that the company issues and then repurchases through the buyback. Alternatively, this could be equal to the value of the shares ever placed on the market.
Just like with retained earnings, the value of own shares generally does not require any calculation. In the company taken as an example, this is equal to € 15,000
Step 5. Calculate the net worth
Add the share capital with the retained earnings and finally subtract the repurchase of own shares; in this way you find the net worth.
If you always consider the same company, you have to add up the share capital (€ 300,000) with the retained earnings (€ 50,000) and subtract the repurchased own shares (€ 15,000); by doing so you get the value of € 365,000, equal to the net worth
Calculation of Net Equity for Companies in Simplified Accounting Regime
Step 1. Companies that have the right requirements for a simplified accounting regime can perform the following calculation:
Sum of closing inventories + Total cost of depreciable assets net of related depreciation + Other fixed assets or assets.
Advice
- Equity is sometimes referred to as "equity" or "equity"; this terminology is interchangeable.
- It is easy to confuse the share capital with the net one; however, always remember the substantial difference between the 2 concepts. Check carefully the sources from which you draw information, so as not to make mistakes.
- Always be alert to any changes related to accounting regulations. A change in the classification of items that fall under liabilities or assets leads to a change in the calculation of a company's equity.
