Financial Explainer — shareholders equity

If you're managing a small business and find understanding your financial statements tricky, this is for you. This blog is one of a series designed to help small company owners and their management teams, where they're not financial experts, get to grips with the detail of their accounts and finances.

This is so you're better positioned to interpret the numbers behind your company's performance and prepared to raise finance when you need it (as investors and lenders will always want detail on your current and forecast financials).

This time we're looking shareholders' equity. You'll find it listed at the end of your balance sheet, after total liabilities.

As a reminder, your balance sheet is built on this formula:

Assets = Liabilities + Shareholders' Equity

We've covered assets and liabilities so there's only shareholders' equity left to define here.

Shareholders' equity represents the portion of a company that belongs to its owners, after paying off all its debts (liabilities)

From the calculation, you'll be able to see:

• If your company's assets increase (e.g. because you sold more goods or services at a profit), your equity will usually grow too.

• If your liabilities grow, your equity may shrink unless your assets grew by the same amount (e.g. you bought some stock on credit from a supplier or took out a bank loan to buy new equipment).

Now let's look at the components of shareholders' equity:

• Share capital: This is the money your company received from selling shares to its owners (shareholders). You may want to think of it as the 'base money' shareholders have invested in your company.

• Share premium: If your company sells shares for more than their basic value (fair or par value), the extra money is recorded here.

• Retained earnings: This is the profit your company has made over time but hasn't yet paid out to shareholders as dividends. It's money kept in the company to help it grow.

• Reserves: These are special funds set aside for specific purposes. For example, legal requirements or emergencies.

• Other comprehensive income: These are the gains and losses that aren't part of your company's main profits. For example, unrealised changes in the value of investments or currency differences (if your company operates in other countries).

• Treasury shares: If your company buys back its own shares, the cost is deducted here. It's worth noting that these shares are not counted as part of the active shares owned by investors.

• Non-controlling interests (if applicable): If your company owns most of another company but not all of it, this is the part of equity that belongs to the other owners of that company.

• Other equity items: This includes things like employee stock options.

So as you can see, shareholders' equity is the owners' piece of the financial pie. It shows what's left for shareholders after debts are paid.