Shareholder’s equity is a part of the balance sheet. It represents the equity portion of the accounting equation presented in the financial statement. In most cases, it includes prevalent items such as ordinary stock, retained earnings, and other reserves. Some people may wonder how shareholder’s equity is different from retained earnings. Before that, it is crucial to understand both.
What is Shareholder’s Equity?
Shareholder’s equity refers to the total equity a company reports on its balance sheet. It represents the difference between the assets and liabilities of a company. In accounting, it is the residual interest of shareholders in that company. This residual interest comes after deducting its liabilities from its assets. The accounting equation also reflects the definition of shareholder’s equity.
Shareholder’s equity refers to the owners’ claim to a business’s assets after liquidation. It is an accounting estimate of how much shareholders will receive if the company gets liquidated. Usually, it includes any compensation received from shareholders for the shares issued to them. On top of that, it also consists of any profits not distributed among them. These profits are known as retained earnings.
Shareholder equity is the overall capital in a company. This capital is the right of its shareholders. Usually, it comes from the first source of finance that the company receives through stock sales. Over the years, it also includes retained earnings and other reserves generated as a part of operations. While mostly positive, it can also be negative in some cases.
What are Retained Earnings?
Retained earnings represent any undistributed profits generated as a part of the business. On top of that, it also accounts for any losses during that period. Essentially, it accumulates all profits and losses under a single balance on the balance sheet. Before that, it removes any distribution to the shareholders. This distribution usually occurs through dividends.
Retained earnings are a source of internal finance for the company. Like shareholder’s equity, retained earnings are also attributable to the shareholders. Therefore, the balance appears under that heading on the balance sheet. Retained earnings increase as companies make periodic profits. On the other hand, this balance decreases with losses and dividend payments.
Like shareholder’s equity, retained earnings are usually positive. However, the balance can also be negative when the losses exceed profits. A negative retained earnings balance also contributes to the shareholder’s equity balance going negative. Retained earnings do not have further components, unlike shareholder’s equity.
Shareholder’s Equity vs Retained Earnings: What is the difference?
Shareholder’s equity includes any capital attributable to shareholders. Retained earnings are a part of that capital. However, shareholder’s equity also includes additional components. For example, it also consists of ordinary shares, preferred stock, and other reserves. In short, shareholder’s equity contains a set of the account balance as a part of equity.
Retained earnings are a part of shareholder’s equity. Therefore, this balance is not fundamentally different from the latter. However, retained earnings only encompass a single head on the balance sheet. Unlike shareholder’s equity, this balance does not include further classifications. On top of that, it only consists of profits or losses. It does not consider capital from other sources.
Conclusion
Shareholder’s equity represents the capital attributable to shareholders in a company. It comes from the difference between assets and liabilities for that company. Usually, it includes various balances, including ordinary shares, preferred stock, and retained earnings. Retained earnings represent accumulated profits and losses after deducting dividends.
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