The total equity of a business is derived by subtracting its liabilites from its assets. The information for this calculation can be found on a company’s balance sheet, which is one of its financial statements. The asset line items to be aggregated for the calculation are:
- Marketable securities
- Accounts receivable
- Prepaid expenses
- Fixed assets
- Other assets
The liabilities to be aggregated for the calculation are:
- Accounts payable
- Accrued liabilities
- Short-term notes
- Unearned revenue
- Long-term debt
- Other liabilities
All of the asset and liability line items stated on the balance sheet should be included in this calculation.
For example, the balance sheet of ABC International contains total assets of $750,000 and total liabilities of $450,000. The calculation of its total equity is:
$750,000 Assets – $450,000 Liabilities = $300,000 Total equity
An alternative approach for calculating total equity is to add up all of the line items in the shareholders’ equity section of the balance sheet, which is comprised of the following items:
- Common stock
- Additional paid-in capital
- Retained earnings
- Less: Treasury stock
In essence, total equity is the amount invested in a company by investors in exchange for stock, plus all subsequent earnings of the business, minus all subsequent dividends paid out. Many smaller businesses are strapped for cash and so have never paid any dividends. In their case, total equity is simply invested funds plus all subsequent earnings.
The derived amount of total equity can be used in the following ways:
- By lenders to determine whether there is a sufficient amount of funds invested in a business to offset its debt.
- By investors to see if there is a sufficient amount of equity piled up to press for a dividend.
- By suppliers to see if a business has accumulated a sufficient amount of equity to warrant being extended credit.