Shareholders’ equity is a set of accounts that represent the ownership of a corporation. It’s one of the three major sections of a balance sheet, along with assets and liabilities. One account within the shareholders’ equity section is retained earnings, which reports the profits earned by the company since it began.
The Balance Sheet
A balance sheet is divided into assets, liabilities and shareholders’ equity. Assets are things that a business owns, including cash, inventory, accounts receivable, property and equipment. Liabilities are things that a company owes, including wages payable, taxes payable and long-term debt. The balance sheet equation states that shareholders’ equity equals assets minus liabilities. One way to think about shareholders’ equity is that it would be equal to the company’s assets if it had no liabilities.
Shareholders’ equity is divided into subsections for share capital and retained earnings. The share capital is the money the business raised by selling stock to shareholders. The basic type of stock is called common stock, and it gives voting rights to shareholders. Common stock shares may pay dividends, which are payments of cash or additional shares to shareholders. Preferred stock can also be issued. It pays dividends but might not have voting rights. The other major subsection of shareholders’ equity is retained earnings.
Retained earnings are the accumulated profits of the company. For a given period, such as a quarter, the ending value of retained earnings on the balance sheet is equal to the ending value from the previous period plus profits or minus losses for the current period, minus any dividends paid during the period. You can think of retained earnings as the money saved up by the company, available to pay for dividends or for other purposes, such as purchasing equipment, buying back stock from shareholders, acquiring another company, paying off debt or undertaking a new project.
The directors of a company control the issuance of dividends. Cash dividends are a way for a corporation to share some of its profits directly with its shareholders. The dividend amount is subtracted directly from retained earnings. If retained earnings are low, company directors can skip, reduce or cancel dividends in order to preserve cash. Some companies work hard to maintain or grow their dividend rate or cash dividend per share without interruption. Other companies, notably in the high-tech sector, don’t pay dividends at all, as they would rather use retained earnings for other purposes such as research and development. Dividend yield, which is the annual cash dividend divided by current share price, is one of the many factors investors consider when trading shares. Dividends are typically paid quarterly.
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