How to calculate total equity
/The total equity of a business is derived by subtracting its liabilities from its assets. This is an essential item that is reviewed by many creditors, lenders, and investors, since it is a strong indicator of the financial strength of a business. A business with a large amount of total equity is in a better position to cover its liabilities, while one with a negative equity balance could be on the verge of bankruptcy.
The information needed to derive total equity 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 cash, marketable securities, accounts receivable, prepaid expenses, inventory, fixed assets, goodwill, and other assets. The liabilities to be aggregated for the calculation are accounts payable, accrued liabilities, short-term debt, unearned revenue, long-term debt, and other liabilities. All of the asset and liability line items stated on the balance sheet should be included in this calculation.
An alternative approach for calculating total equity is to add up all of the line items in the stockholders' equity section of the balance sheet, which is comprised of common stock, additional paid-in capital, and retained earnings, minus 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.
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Example of Total Equity
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
How to Use Total Equity
The derived amount of total equity can be used by lenders to determine whether there is a sufficient amount of funds invested in a business to offset its debt. It can also be used by investors to see if there is a sufficient amount of equity piled up to press for a dividend. And finally, it can be used by suppliers to see if a business has accumulated a sufficient amount of equity to warrant being extended credit.
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