The Retained Earnings Formula and Shareholders’ Equity
We’re almost through the entire balance sheet and will walk through the equity portion of the balance sheet. The equity section is found on the right hand side of the balance sheet which includes Capital Stock and Retained Earnings (we’ll go through the retained earnings formula below). If you missed any of the other posts on the balance sheet, make sure to check out the balance sheet equation, current assets, net fixed assets or balance sheet liabilities for an overview.
Let’s start out with the balance sheet equation to review. Since we’ve gone through all the assets and liabilities, we can now calculate the size of the equity portion using the formula below:
One way to think about this is to take the value of everything a company has and then subtract off all of its debt. Anything that’s left over is value to the owner which we call equity. To put it on a personal level, say you own a house valued at $200,000 and owe $150,000 of debt. To calculate the amount of your equity, we can subtract off the value of the assets minus the debt which is $50,000 ($200,000 – $150,000 = $50,000). So as we go forward, just keep in mind that shareholder’s equity is really just the amount of value left for the owner after debt is subtracted off the assets.
Capital stock is the amount of money that the owners invested in the company either when the company was starting up or if it needed more cash after being in operation. To show that they contributed money into the company, the owner gets shares of capital stock in the company. The more shares of stock that they have, a larger portion of the company that they own. The amount of capital stock shown on the balance sheet will stay constant unless the company has an equity offering, meaning that it sells more shares of stock to take in more cash.
Retained Earnings Formula
The other portion of shareholder’s equity is the retained earnings of a company. In the Net Income Formula and How to Calculate Profit post, we worked through the income statement to calculate the net profit of a company. When a company makes a profit, we have two decisions: they can either pay the profit to their owners (the people who own capital stock) in the form of dividends or they can keep it in the company for the future (called retained earnings). The retained earnings formula is:
Retained Earnings = Total of all Net Profits – Total of all Dividends
What the retained earnings formula means is that the value of retained earnings on the balance sheet is a running total of how much of the profits that a company has kept instead of giving to its owners. Even if a company chooses to keep the money for now, it call always pay out some of the retained earnings later to its owners.
Now that we’ve got retained earnings and capital stock, we can calculate the Shareholders’ Equity by adding the two together as in:
Shareholders’ Equity = Capital Stock + Retained Earnings
Finishing Up the Right Hand Side of the Balance Sheet – Total Liabilities & Equity
Now we have all the information that we need to calculate the Total Liabilities & Equity of the company. For this, we can add up the Current Liabilities, Long-Term Liabilities and Shareholder’s Equity using the formula below:
Now we’ve gone through the whole balance sheet so awesome job! The final thing to do is make sure that the Total Assets equals the Total Liabilities & Equity. If you’ve got a balancing Balance Sheet, you’re ready to roll. If you liked this overview, make sure to sign up for the mailing list to get exclusive updates, templates, and tools.
Key Takeaway: Shareholder’s equity is the value that’s left after debt is subtracted form the value of the company’s assets. Shareholder’s Equity is usually split into capital stock and retained earnings and is the total value of the company to its owners. Using the retained earnings formula, you can calculate a company’s retained earnings by subtracting the total dividends by the company’s net profit.