The value of a company after deducting all of its liabilities is referred to as its total equity. Let’s learn the concept of total equity, and the methods used for its calculation with this simple guide. This guide will also evaluate the average total equity formula, the return on equity formula, and the total equity formula on a balance sheet
What Is Total Equity?
First and foremost, equity is the value of the company that is still available or remaining to its shareholders or owners (if it’s a private business) after the company has paid off all of its debts. It is also known as “owners’ equity” (for private corporations) or “shareholders’ equity” (multiple owner corporations). In a corporate setting, there are two basic types of equity such as common stock and preferred stock.
Supposing a business is experiencing a financial meltdown and is forced to shut down, and needs to undergo a liquidation process (converting all of its assets into cash to pay off its debts), total equity is the amount of money that is given back to the company’s shareholders at the end of the process. One could perhaps consider it the same as a company’s book value.
Furthermore, you can find the total equity on the bottom right-hand side of the majority of balance sheets. A company’s balance sheet is a type of financial statement that reports the total assets, total liabilities, and total equity of the business.
After all debts and dividends to preferred stockholders and creditors have been paid, the leftover equity will then be distributed to the holders of common stock. Hence, Shareholders of preferred stocks receive payment for any residual equity first, ahead of shareholders of common stocks.
Types of Total Equity
As was said previously, there are two distinct categories of equity. Let’s get into further depth about them, shall we?
#1. Preferred Stock
It is one of a business ownership unit. If you possess preferred stock, then you have specific rights that common stockholders do not. If the company goes out of business, preferred shareholders are normally compensated before common share stockholders. Preferred shareholders, in other words, receive stock from a corporation before common shareholders.
#2. Common Stock
It is also a business ownership unit. If you own common stock, you are only entitled to any remaining share in the company after all creditors and preferred stockholders have been paid. Thus, the majority of stockholders own common stock.
Total Equity Formula
Total equity formula is derived from the general accounting equation. Ie Assets = Liabilities+ Equity. In other words, following arithmetics operations, total equity formula will be
Total Equity = Total Assets – Total Liabilities
Where
- Total assets: A company’s total assets are everything it owns. It comprises cash, investments, and equipment.
- Total liabilities: A company’s debts. Short-term and long-term loans and creditor debts.
NB: Remember that if the outcome is negative, liabilities surpass assets, and the business owners have no remaining equity.
Examples of How to Calculate Total Equity
The following are some examples of how to calculate total equity.
Example 1:
Quickspace Inc. has total assets of $48,000 and total liabilities of $36,000. What is its total equity?
Using the above formula,
Total Equity = Total Assets – Total Liabilities
$48,000 – $36,000
Total equity = $12,000
Example 2
Company X had a $50,000 property, $25,000 building, $20,000 equipment, $11,000 inventory, $6,000 accounts receivables, and $15,000 cash in 2020. The company owes the bank $30,000 and creditors $10,000. What was Company X’s 2020 equity at the end of the year?
Solution:
Firstly, add up the total assets and liabilities
Total Assets = $50,000 + $25,000 + $20,000 + $11,000 + $6,000 + $15,000 = $127,000
Total Liabilities = $30,000 + $10,000 = $40,000
Afterward, employ the formula
Total Equity = Total Assets – Total Liabilities
$127,000 – $40,000
Total Equity = $87,000
Example 3:
Eddy and Sons Ltd owes $450,000 and has $300,000 in assets. There are 5,000 shares of common stock and 2,000 shares of preferred stock held by the firm as outstanding shares. Determine the total amount of equity.
Solution:
The formula still remains the same regardless of the outstanding stocks.
Total Equity = Total Assets – Total Liabilities
$300,000 – $450,000
Total Equity = -$150,000
Evidently, we get a negative answer here, which indicates that the owner and shareholders do not have anything to share as their portion of the company’s residual worth.
Total Equity Formula On a Balance Sheet
A financial statement known as the balance sheet provides a comprehensive summary of the company’s overall assets, liabilities, and equity in a tabular format. The following procedures need to be taken using the balance sheet in order to calculate total equity:
- Find the value of the total assets on the balance sheet, as well as the value of the total liabilities.
- To determine the total equity, start by calculating the total liabilities, then deduct those from the total assets.
There is a second method or formula for calculating the total equity using the balance sheet, which is the following
- Firstly, on the balance sheet, look for the part marked shareholder’s equity.
- Secondly, you add all of the items together, including common stock, additional paid-in capital, and retained earnings.
- Finally, subtract the treasury stock value from the total in Step 2.
This alternate equation for calculating total equity on a balance sheet has the following formula:
Total Equity = Common Stock + Preferred Stock + Additional Paid-in Capital + Retained Earnings – Treasury Stock.
Return on Total Equity Formula
The return on equity (ROE) is a financial performance metric that is determined by dividing net income by shareholder equity. Because shareholder equity equals a company’s assets minus its debt, ROE is also known as return on net assets. The return on total equity is a formula that is used to evaluate the efficiency with which a company’s management turns its assets into profits.
Comparing one firm with its competitors and the whole market is a common usage of ROE. If you are comparing companies in the same industry, the method is particularly useful in determining which companies are functioning more efficiently, and it can be used to evaluate almost any company with mostly tangible rather than intangible assets.
Therefore, the formula for return on total equity is
Total return on equity = Net Income/ Shareholder equity
Where
- Net Income = The net income disclosed on a company’s income statement is the bottom-line profit before common-stock dividends are paid. Free cash flow (FCF) is a type of profitability that can be used in place of net income.
- Shareholder equity = Assets minus liabilities on a corporation’s balance sheet equals shareholder equity, which is the financial value left for shareholders if a company pays off its liabilities with its assets.
It is also possible to calculate return on equity over different periods to see how it has changed over time. Investors can track changes in management performance by comparing the growth rate of return on equity from year to year or quarter to quarter for example.
Average Total Equity Formula
The average total equity is the average of the equity values recorded on the balance sheet at several reporting periods. Generally, you can calculate average total equity by averaging equity carrying values from the end of the previous year’s results and those from the end of the current year’s results.
To get the ROE calculation, we generally use the average total equity as one of the major financial ratios used to analyze an organization’s capacity to profitably employ its resources or equity.
We may calculate average total equity by multiplying the current year’s total equity value by the prior year’s total equity value and then dividing the result by two.
The following is the formula is:
Average Total Equity = Total Equity (current year) + Total Equity (previous year)/2
Average Total Equity Example
| Exracted Balance sheet | 31st December 2020 | 31st December 2021 |
| Current liabilities | $ | $ |
| Interest Payables | 800 | 950 |
| Account payables | 3,600 | 4,100 |
| Accruals | 2,000 | 3,300 |
| Other current liabilities | 1,000 | 600 |
| 7,400 | 8,950 | |
| Non-current liabilities | ||
| Note payables | 20,000 | 38,000 |
| Other non-current liabilities | 4,300 | 4,300 |
| 24,300 | 42,300 | |
| Total liabilities | 31,700 | 51,250 |
| Equity | ||
| Share capital | 70,000 | 70,000 |
| Retained earnings | 25,650 | 16,500 |
| Profit/(Loss) current year | 16,470 | 10,000 |
| Total equity | 112,120 | 96,500 |
| Total liabilities and equity | 143,820 | 147,750 |
Calculate the average total equity in 2021 based on the extracted balance sheet above.
Solution
Total equity value on 31 Dec 2020 = $112,120
Total equity value on 31 Dec 2021 = $96,500
Therefore,
Average Total Equity = Total Equity (current year) + Total Equity (previous year)/2
Average Total Equity = (112,120 + 96,500) / 2
= $104310
Bottom Line
In conclusion, total equity is about what a corporation would have if it sold all of its assets and used the proceeds to settle all of its debts. Here, we’ve done a good job explaining the formula for determining your total equity. Note that you can use this strategy to track your company’s profitability if you’re a business owner.
FAQs
Is total equity the same as total assets?
Total equity, or shareholder equity, is total assets minus total liabilities on a company’s balance sheet. While total assets equal current + non-current assets.
Does total equity include retained earnings?
On the balance sheet of a company, total equity includes the retained Retained earnings are part of a company’s equity on its balance sheet.
Where is total equity on financial statements?
A company’s equity position is on its balance sheet, in the column on the right.
What is another name for total equity?
Shareholder equity is also known as shareholders’ equity, stockholder equity, or stockholders’ equity.
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