Entrepreneurs and managers need to have extensive knowledge about indicators that are useful to evaluate their businesses’ performance. Among this knowledge, knowing how to calculate the shareholders’ equity stands out.
Based on these data, it is possible to check important information, such as an organization’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?
Everything your company owns is an asset, right? Informatics equipment, vehicle fleet, bank account balance, financial investments, real estate, etc. If for any reason you decide to close down your business, could the assets of your company pay its debts? The calculation of the shareholders’ equity gives us that answer.
Logically, no business has the goal of ending its activities. Every enterprise works by acquiring debts that stimulate its activities, generating assets that pay for such debts. Even so, it is very important to know the result of this calculation, since the shareholders’ equity is an indicator of the company’s financial health.
A negative shareholders’ equity can suggest to the partners that this is not the right time for the company to make investments, for example – instead, the priority for that period is to invest in strategies aimed at saving resources.
How to calculate the shareholders’ equity?
The shareholders’ equity is the result of the following calculation: assets – liabilities. The assets are on the left side of the balance sheet, representing all the rights that the company has to receive.
To the right of the balance sheet are the liabilities, which reveal the amounts of debts and obligations of the company. This calculation includes several amounts, such as employee payroll, financing operations, loans, suppliers, etc.
A balance sheet showing the amount of $ 100,000 as shareholders’ equity indicates that, if the company were to close down at that moment, the entrepreneur would pay all debts and still go out of business with that amount.
Since the shareholders’ equity indicates the company’s financial health, it is among the factors that influence banks to grant, or not, loans to the 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 too 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 monitor the shareholders’ equity?
The best way to accurately observe information on any area of a company is to have access to its financial statements. The same rule applies to shareholders’ equity. It is possible to check your transactions through a Statement of Changes in Shareholders’ Equity, also known as SCSE.
The SCSE 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 regarding the company’s financial health to the manager. Based on them, they can check what measures should be adopted in the next fiscal year, and even assess if there is any emergency action. Due 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.
Given that the statement of changes in shareholders’ equity aims to measure all the financial changes it goes through, some information should not be overlooked 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;
- equating the losses obtained;
- 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, check whether the company in question has had a satisfactory performance. To this end, using ROE (Return on Equity) is recommended to make an effective verification. Learn about it!
Return on Equity (ROE)
ROE is a methodology created with the purpose of measuring the profitability of companies, based on their shareholders’ equity. The idea behind it is simple: it boils down to the premise that, the lower the capital used by a business 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 organizations are indeed profitable.
How to calculate ROE
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 shareholders’ 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 the 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, the manager has access to a powerful indicator of its financial situation. If the information is incorrect or misinterpreted, the organization 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.
What are shareholders’ equity rectifying accounts and how do they work?
Understanding rectifying accounts is as important as knowing how to calculate the shareholders’ equity. They are essential for shareholders to have access to the correct data of a business, such as gross profit.
Basically, they are a group of accounts used to adjust the balance of the same group of accounts in the balance sheet. Therefore, at this point, it is important to know how to calculate shareholders’ equity. These accounts can be inserted in both liabilities and assets, or even directly in the organization’s equity.
Rectifying accounts are also commonly referred to as reducing accounts. This is because they affect the balance of the group in which they are inserted, decreasing it. As a result, when the amount in this account increases, the total amount of where it is grouped decreases. Next, learn about the most recurring reducing accounts.
Allowance for doubtful accounts (ADA)
This account model is among the current asset rectifying accounts. It refers to default, which is very common in sales paid in installments. In this sense, the ADA was created with the goal of including this amount, which represents a costly loss to the company’s results.
Thus, it is opposed to the field of accounts receivable and, based on its sum, it is possible to generate the net balance of current assets.
This account is among a company’s fixed assets. Basically, its role is to calculate the loss of value of a good, resulting from wear and tear, normal obsolescence or nature’s action. It usually includes real estate and machinery.
Therefore, depreciation is the record of the organization’s loss of materials. It occurs only in the assets classified in property, plant and equipment and in the income assets in the investment or non-current asset groups.
Asset reducing accounts
In order to understand how to calculate the shareholders’ equity, it is important to know the asset reducing accounts. Among them are the capital to be paid in and the duplicate discounted.
The former includes the amounts that will be paid by the company’s partners to the organization itself. The latter – which is a liability reducing account – has a credit balance. As a result, the amount of the duplicate paid by the debtor will be included in the balance of the business. Thus, its increase decreases the enterprise’s expense accounts.
How do equity valuation adjustments work?
This adjustment is part of the group of accounts that make up the shareholders’ equity. Therefore, it is essential to understand it in order to know how to calculate your company’s shareholders’ equity. This adjustment relates to the result of the valuation of the assets compared to their fair value.
Its purpose is to ensure that the fair value stipulation can occur in such a way that the elements that drive the settlement of the transaction do not interfere with the value’s final result.
Therefore, the Equity Valuation Adjustments are the results of the decrease or increase of the components of the asset, or the liability – which were not added to the calculation of the fiscal year due to revaluation.
Once you understand how to calculate and monitor the shareholders’ equity, what the rectifying accounts are and how equity valuation adjustments work, it is possible to use your results to measure your business’s financial health. That way, you ensure a secure financial future, as this calculation shows the real situation of a company. In addition, it is very useful for planning future investments.
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