Stockholders' equity, also known as shareholders' equity or owners' equity, represents the value of each stockholder's ownership or share of a given company. As a business, it's important to highlight these amounts and their changes throughout a given period of time — typically from the beginning to the end of the year. To do so, you should create a stockholders' equity statement, which is a financial document that outlines your total capital per shareholder.
Here's what you need to know about creating a stockholders' equity statement.
What is stockholders' equity?
A stockholders' equity statement is part of a company's balance sheet, consisting of share capital and retained earnings (assets minus liabilities). The document breaks down the value of stockholders' ownership interest in a company during a specific accounting period, typically measuring any changes from the beginning to the end of the year.
[Read more: Creating a Financial Accounting Report With the Four Basic Statements.]
This helps companies better understand their financial health and make any necessary changes. It can also help you attract potential investors to your business, especially if your balance continues to rise at a steady rate. Because shareholders’ equity frequently changes, it is crucial to review this information regularly so you understand how to adapt and move forward.
Privately owned companies do not always have stockholders, so if your private business has never sold any equity shares, you don't have to create a stockholders' equity statement. However, if you are publicly owned (or if your private company has investors with equity in the business), you'll want to understand what goes into creating this document so you can ensure you're including the right information.
When do businesses need a stockholders' equity statement?
Businesses typically need a stockholders' equity statement for the following purposes:
- To track changes in equity over time: Statements of stockholders' equity help businesses monitor the growth or decline of their shareholders' equity, which can be influenced by factors like profits, losses, dividends, and stock issuances.
- For financial reporting: Stockholders' equity statements are essential tools to assess the financial health of a business.
- To comply with regulatory requirements: Regulatory bodies, such as the U.S. Securities and Exchange Commission, require eligible companies to file stockholders' equity statements to ensure transparency and accountability.
- To make informed business decisions: By analyzing changes in stockholders' equity, businesses can identify trends and make informed decisions about future investments, capital structure, and dividend policies.
[Read More: 10 Free Accounting Tools for Your Small Business]
A strong statement of stockholders' equity can help you attract investors. This is your opportunity to put your best foot forward and show your company's potential for success.
What information goes in a statement of stockholders' equity?
A statement of stockholders' equity provides a detailed breakdown of the changes in a company's ownership stake over a specific period. The four primary components of a statement of stockholders' equity are:
- Share capital: The total amount of money a company has raised by issuing shares of stock, including common stock and preferred stock.
- Net income: The profit or loss generated by the company's operations during a specific period, representing additional earnings retained by the company.
- Dividends: Payments made to shareholders from the company's profits, representing a distribution of earnings.
- Retained earnings: The portion of a company's net income that is retained and not distributed as dividends, which is then reinvested into the business to fund growth and future projects.
There is much to consider when creating a stockholders' equity statement, like different types of stock and any additional gains or losses. While calculating these amounts, do not leave any of these details out of the equation.
Most stockholders' equity statements include the following:
- Preferred stock, which provides a higher claim on company earnings and assets and often entitles its holders to dividends before common stockholders.
- Common stock, which entitles holders to voting rights within the corporation but places them at a lower priority than bondholders and preferred stockholders when divvying up equity holder payments in the event of liquidation.
- Treasury stock, which is repurchased by the issuing company for purposes like avoiding takeovers and boosting stock prices.
- Additional paid-up capital, or contributed capital, which is the amount investors pay over their par value.
- Other comprehensive income (OCI), which includes unrealized gains and losses on investments, foreign currency translation adjustments, and pension adjustments.
Once you define and outline this information, you'll better understand your company’s financial well-being and performance, as well as how investors view your business’s potential. From there, you might sell additional shares, streamline the circulation of shares, or distribute profits.
How to create a stockholders' equity statement
To create a stockholders' equity statement, follow these steps:
- Gather financial information, including your company's beginning equity balance, new investments, net income/loss, dividends paid, and other adjustments.
- Add new equity contributions, including any additional investments made by shareholders or owners.
- Add net income or subtract net loss based on your company's profitability or lack thereof.
- Reduce the balance by the amount of dividends paid to shareholders.
- Add or subtract other adjustments, accounting for other nonroutine transactions like stock repurchases or issuances.
- Add up all adjustments to the beginning balance to determine the final equity value.
Common mistakes in stockholders' equity statements
Some mistakes that affect the accuracy of a stockholders' equity statement include the following:
- Misclassified assets and liabilities: Incorrectly classifying assets or liabilities can lead to an overstatement or understatement of equity. For instance, misclassifying a long-term asset as a current asset can artificially inflate equity.
- Errors in calculating retained earnings: Mistakes in calculating net income or dividends can directly impact retained earnings. Errors in revenue recognition, expense allocation, or dividend distributions can lead to inaccurate calculations.
- Omitting OCI line items: Failing to include other comprehensive income (OCI) items, such as unrealized gains and losses on investments or foreign currency translation adjustments, can provide an incomplete picture of equity changes.
To avoid these and other errors, carefully review financial statements, ensure your accounts are reconciled, and consult with a financial professional if needed.
[Read More: Accounting Basics Every New Business Owner Should Learn]
How to use equity statements to attract investors
A strong statement of stockholders' equity can help you attract investors. This is your opportunity to put your best foot forward and show your company's potential for success. By understanding the dynamics of equity at your company, investors can make informed decisions about where to allocate their capital.
To attract investors with your equity statement, consider these tips:
- Highlight your strengths. Showcase your company's strong financial performance, including rising profits, positive cash flow, and consistent dividend payouts.
- Paint a promising future. Discuss exciting growth opportunities, strategic initiatives, and innovative projects that can drive future value.
- Keep it simple. Present your statement in a clear and concise manner, avoiding complex jargon.
- Be consistent and timely. Adhere to high standards when it comes to reporting and provide regular and reliable updates to keep investors informed.
- Make it visually appealing. Use high-quality charts and graphs to make your financial data more engaging.
- Address investor concerns head-on. Be proactive by anticipating any potential concerns and providing clarity wherever needed.
This article was originally written by Sean Peek.
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