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.
Related AccountingTools Courses
Business Ratios Guidebook
The Interpretation of Financial Statements