What is A Statement of Stockholders’ Equity and Why Is It Important?

A balance sheet contains many elements, one of those elements is the statement of shareholder equity. That statement is representative of the changes in the value of the business to shareholders. The changes displayed are for a particular accounting period. An increment in the statement of shareholder equity signifies that the activities the business is pursuing to increase income are paying off and vice versa. Let’s find out more about the statement of stockholders’ equity now.

Statement of Stockholders’ Equity: All You Need to Know

What is a statement of stockholders’ equity?

The statement of shareholders’ equity gives shareholders, investors or the company’s owner a picture of how the business is performing, net of all assets and liabilities.

The statement of stockholders’ equity is a representation of the difference between the total assets and liabilities. The statement of stockholders’ equity is the difference between total assets and total liabilities, and is usually measured monthly, quarterly or annually. It’s present on the balance sheet, which is one of three financial documents that are important to all small businesses. The income statement and cash flow statement are also found on the balance sheet.

Stockholders’ equity only witnesses increments when capital contributions by the business owner/investors increase or if the business’s profits improve as a result of increased sales or increased margins by cost cutting.

Some small business owners may overlook the statement of stockholders’ equity if they are focused only on money coming in and going out. But income shouldn’t be your only focus if you want a good idea of how your operations are faring.

“The statement of shareholder equity tends to be overlooked because people focus on the profit-or-loss statement or cash flow,” says Craig M. Steinhoff, a certified public accountant and a member of the American Institute of CPAs’ Consumer Financial Education Advocates. This section is important, however, because it helps business owners evaluate how their business is doing, what it’s worth and what are good investments, he said.

The statement of stockholders’ equity tends to intimidate several small business owners at times. The reason behind that is the fact that it is slightly more complicated than a basic income statement. However, if you break it down into simple segments, it becomes simpler and more palatable.

“Business owners overlook the statement of shareholder equity because they don’t understand it,” Steinhoff said. “But it’s easier to invest the time in educating yourself, whether through researching online, talking to an advisor or finding a mentor. This is extremely important. It’s never too late to learn.”

Who uses a statement of stockholders’ equity?

The statement of stockholder equity is useful for companies of varying types and sizes. Whether it’s a small business or a massive, multinational, publicly traded conglomerate, the statement of stockholder equity is essential. For non publicly traded companies, regardless of size, the statement of stockholder equity is often considered the owner’s equity.

“If you have more than a sole proprietorship, it’s always a good idea to have a statement of stockholder equity,” said Meredith Stoddard, life events experience lead at Fidelity Investments. “It’s an important document that spells out where the assets and liabilities are, and who owns what.”

Why should you use a statement of stockholders’ equity?

For a business owner, it’s imperative to know how the business is faring over a certain period of time. Without a statement of shareholder equity, it is extremely tough to do that. Here’s why you should use the statement of stockholders’ equity:

Helps you make financial decisions.

Listing a business’s worth post payment of expenses is critical for future planning. A statement of stockholder equity can let you know if you should borrow money for expansion or you should cut costs. It can also tell you if you are going to make a profit on a sale or not. You can also attract investors through it. Investors prefer going through the statement of stockholders’ equity before investing any money.

Tells you how well you’re running your business.

A statement of stockholder equity is useful for gauging how well the business owner is running the business. A decline in stockholder equity is a surefire sign of something wrong with the firm.

Helps you get through financial difficulties.

The statement of shareholder equity is also important in trying times. It tells you if you didn’t make enough to sustain operations. It can also reveal whether you have enough equity in the business to get through a downturn, such as the one resulting from the COVID-19 pandemic. The statement of shareholder equity shows whether you are on sound enough footing to borrow from a bank, if there’s value in selling the business and whether it makes sense for investors to contribute.

What does the statement of stockholder equity include?

A statement of stockholders’ equity can have different components based on the size of the business. Here are some of the commonly present elements:

Preferred stock

This is a company’s share/ownership stake that has been issued as an equity or a stock. Preferred stockholders are given preference over common stockholders when it comes to dividends and the distribution of assets.

Common stock

This is also a share in the company, but it takes a back seat to preferred stockholders when it comes to paying out equity. If a business chooses to liquidate, common stockholders are paid after preferred stockholders. However, common stockholders have the privilege of voting rights, something not enjoyed by preferred stockholders.

Treasury stock

These are the shares that the company buys back, whether to prevent a rival from trying to take over the company or to drive the stock price higher. This type of stock typically pertains to publicly traded companies.

Retained earnings

These are the net profits on the income statement that do not get paid out to shareholders or as the owner’s draw. These earnings are then reinvested in the business. For example, they can be used to purchase new equipment, to invest in research and development, or to pay down costly debt.

Contributed capital

This is also called additional paid-up capital in many cases. The contributed capital is the extra sum of money that the investors have to dish out for shares over the par value of the business. This additional capital is created when a company issues new shares, and it can be reduced when the company buys back its own shares.

Unrealized gains and losses

These gains or losses are incurred when the value of the company’s investments change. Unrealized gains occur when the business has yet to cash in those gains, while unrealized losses are those reductions in value before the investment is unloaded.

How do you make a statement of stockholder equity?

Here are the four sections of the statement that you need to create in order to create a complete statement of stockholder equity:

Equity 

The first section shows the equity of the business at the beginning of the accounting period.

New equity infusions

This section lists any new investments that shareholders or owners made to the company for the year. Net income is also included in this calculation.

Subtractions

This section deducts all dividends paid out to investors and any net losses.

Equity balance

This section shows the ending equity balance for the period that is being tracked.

There are some important things that should also be present on the statement of stockholders’ equity. To prevent any confusion later, the heading on the statement of shareholder equity should have the company name. The title of the statement and the accounting period should also be present on these financial statements. So that was our brief take on the statement of stockholders’ equity. Hopefully, you now have a basic idea of the concept and won’t find it very daunting to tackle in the future.

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