Entrepreneurs and managers need to have extensive knowledge about indicators that are useful to evaluate their business’s performance. Among this knowledge, knowing how to calculate the shareholders’ equity stands out.
From this data, it is possible to check important information such as a company’s ability to honor its commitments. Indicators also allow comparisons to be made between two or more companies in the same industry, which makes it possible to identify the most productive among them.
Therefore, it is not an exaggeration to say that it is essential for managers and entrepreneurs to know how to obtain the shareholders’ equity of their companies. Keep reading and find out how to do this calculation!
What are net assets after all?
Every company has assets, doesn’t it? Computer equipment, fleets of vehicles, money in the bank, financial investments, real estate, etc. If for some reason you decide to cease all your company’s activities, would your company’s assets be enough to pay all its debts? Calculating your net assets will provide you with this answer.
Logically, no business intends to pack up shop. Every business acquires debts that stimulate its activities, generating assets that will pay for this acquired debt. Even so it’s very important to know the value of this calculation, because net assets are an indicator of your company’s financial health.
A company with negative net assets may lead its partners to believe that now is not the time to make investments, for example – they should place a priority on applying strategies that will economize resources.
How do you calculate net assets?
Net assets are the result of the following calculation: assets – liabilities. Assets appear on the left side of the balance sheet and represent all of the rights that the company will receive.
On the right side of the balance sheet are liabilities which reveal the company’s debts and obligations. Various things are included here such as company payroll, financing, loans, suppliers, etc.
A balance sheet with net assets of $100 thousand indicates that if the company were to close its doors at that moment, the entrepreneur could pay all of the company’s debts and still leave the business with this amount of money left over.
Since shareholders’ equity indicates the company’s financial health, it is among the factors that influence banks to grant, or not, loans to a business. This would be one more reason to focus on a positive result; after all, the company may lose access to the credit lines if the shareholders’ equity result is very negative. This can jeopardize your growth.
Suppliers can also rethink the partnership if the balance sheet indicates that the company has already incurred many debts. It is not a rule, but it is possible. Accountants cite this calculation as one of the crucial analysis information when reading a balance sheet.
How to keep track of the shareholders’ equity?
The best way to accurately observe information on any area of a business is to have access to its financial statements. The same rule applies to shareholders’ equity. It is possible to check your transactions with a statement of changes in equity, also known as SCE.
SCE is nothing more than a report prepared based on all the changes made in the shareholders’ equity of a company in a predetermined period of time.
The purpose of the report is to provide secure information on the company’s financial health to managers. Based on these, they can check what measures they should adopt in the next fiscal year, and even assess if there is any emergency action. Thanks to this agility, problems can be identified and solved more easily.
Considering the importance of the financial statement, it is essential to carefully prepare it, so that it can clearly express all the capital inflows and outflows in the company’s cash.
Since the statement of changes in equity is intended to measure all the financial changes through which it goes, there is a series of information that should not be left aside at the time of its preparation. Among these we can mention:
- increase or decrease of financial reserves;
- area in which the results verified in the period were applied;
- equalization of losses accrued;
- how the net income for the fiscal year was used.
How to prove the profitability of a company?
Just as important as knowing how to calculate a company’s shareholders’ equity is to have the knowledge needed to evaluate it, and from that data, check whether the company in question has had a satisfactory performance. To that end, using ROE (Return on Equity) is recommended to make an effective verification.
ROE is a methodology created for the purpose of measuring the profitability of companies based on their shareholders’ equity. The idea behind it is simple: it comes down to the premise that, the lower the capital used by a company to make a profit, the more efficient it is.
Therefore, based on the ROE, it is possible to put two or more companies’ side by side and, using the method, define which has the best return on equity. It is also useful for managers to assess whether their companies are indeed profitable.
The calculation of Return on Equity is simple; it calculates the company’s net income in its last fiscal year and divides it by the equity accumulated in the same period. These data can be verified in the institution’s balance sheet or calculated taking into account the average of its last 12 months.
Although the efficiency of ROE is evident, it should not be the only indicator used by entrepreneurs or managers when assessing the company, they manage. Using other methods and systems is critical to have a realistic overview of the business. In addition, using the methodology to compare companies that operate in different fields can affect the accuracy with which data are presented. This is because, given that these companies operate in different areas, they will have different expenses and results, which means that they cannot be assessed with the same metrics.
By evaluating the shareholders’ equity of a company, managers have access to a powerful indicator of its financial situation. If the information is incorrect or misinterpreted, the company in question will face problems and may even go bankrupt.
Taking into account the importance of this data, and the weight it has on the financial health of companies and institutions, it is obvious that it must be observed with great care and attention.
Now you know how to calculate your shareholders’ equity and understand the usefulness of this operation. But there is still a lot of other information that a manager needs! Among them, we can mention the control of finances. Read this article and find out why your company should care about developing a good financial management.