The importance of equity is in the value of an investor’s stake in a company, in other words, it is the proportion of the company’s shares. It means that having stock in a company could give potential for shareholders in terms of capital gains and dividends. Owning equity could also be advantageous like giving shareholders the right to vote on corporate action. Plus they get the chance to elect the board directors. In other words, the ownership of equity could lead to the ongoing interest in the company for shareholders.
However, there are two kinds of shareholder proportion equity that are conflicting. It is the positive and negative shareholder equity. Positive shareholder equity means the company’s assets are enough to cover liabilities. On the other hand, the negative shareholder equity means liabilities are higher than the assets. So, if the liabilities stay higher in a continuous time, it could inflict balance sheet insolvency.
Furthermore, investors believe that negative shareholder equity is a risky investment for them. Although it may become the indication of unsafe investment, shareholder equity alone cannot be the sole decider of a company’s financial health. It must take other tools and metrics to finally decide whether the company has a healthy financial condition.
The formula and the calculation refers to the accounting equation. It is shareholders’ equity = total assets – total liabilities. The information is in the balance sheet. The steps are locating company assets in the balance sheet. Then, listing the total of liabilities in the balance sheet. Finally it should subtract the total of liabilities.