Shareholder equity, also known as stockholders' equity, represents the residual value that remains after a company's liabilities are subtracted from its total assets. It is a key indicator of a company's financial health as it shows the net worth that the owners or shareholders have in the company. Shareholder equity is reported on the company's balance sheet under three major components: common stock, additional paid-in capital, and retained earnings. A positive shareholder equity implies that the company has more assets than liabilities, providing a cushion against financial downturns.
An example of shareholder equity in use is: If a company has assets valued at $1,000,000 and liabilities of $600,000, its shareholder equity is $400,000. This amount signifies the value the shareholders would theoretically receive if the company were to liquidate all its assets and settle its debts. Conversely, negative equity, also referred to as a deficit, indicates financial instability and usually warrants close analysis by investors and stakeholders.