Tag Archives | shareholder’s equity

Book Value of Equity Per Share (BVPS)

See also:
Price to Book Value Analysis
Price to Sales Ratio Analysis

Book Value of Equity Per Share (BVPS) Definition

Book Value of Equity per Share (BVPS) is a way to calculate the ratio of a company’s Stakeholder equity (as stated in the balance sheet) to the number of shares outstanding. Investors commonly use BVPS to determine if a stock price is under or overvalued by looking at the company’s current state.


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Book Value vs Market Value

Investors use both Book Value and Market Value to build strong portfolios. The market price of a stock provides hints to the company’s future growth and financial stability. The book value reveals the current state of a company calculated by its balance sheet. Using both values can assist you in determining whether a stock is valued correctly, thereby helping you invest your money wisely. For example, a company’s BVPS is $4 and the market value is $10. In this case, it does not necessarily mean that the stock is overvalued. However, it might mean that the company’s assets have a high earning power or potential. In comparison, it doesn’t necessarily mean it is an undervalued stock if a company’s BVPS is $4 and the market value is $2. Instead, it might mean that the financial market has lost confidence in the company’s ability to generate future profits.

Book Value of Equity Per Share Formula

Calculate the BVPS of a company by dividing total stakeholder equity (excluding preferred shares) by total shares outstanding. Refer to the following formula to calculate BVPS:

BVPS =  Value of Common Equity / # of Shares Outstanding

Example of Book Value of Equity Per Share (BVPS)

For example, ABC & Co. has $30,000,000 of stockholder’s equity, $7,000,000 of preferred stock, and an average of 5,000,000 shares outstanding during the period measured. Calculate BVPS using the following formula:

$30,000,000 Stockholder’s Equity – $7,000,000 Preferred Stock ÷ 5,000,000 Average Shares Outstanding

= $4.60 Book Value Per Share

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Book Value of Equity Per Share

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Book Value of Equity Per Share

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Balancing the Balance Sheet

See: Balance Sheet

Balance Sheet Definition

The balance sheet is a financial statement that shows a company’s financial position at a point in time. The balance sheet format comes in the following three sections:

The assets represent what the company owns. Then, the liabilities represent what the company owes. Finally, the owners’ equity represents shareholder interests in the company. The value of the company’s assets must equal the value of the company’s liabilities plus the value of the owners’ equity.

This balance sheet formula forms the basis of the statement, also known as the accounting equation.

Assets = Liabilities + Owners’ Equity


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Balancing the Balance Sheet

The “balance” in balance sheet indicates the 2 sides have to balance every time. Therefore, the company‘s assets always have to equal liabilities plus owners’ equity. Now, let’s walk through the steps needed in order to know how to start balancing the balance sheet.

Balancing the Balance Sheet Steps

First, start by putting all the company‘s assets on the left side of the sheet. Let’s start with the current assets. For example:

ASSETS

Current Assets
  Cash                                    $  2,000
  Accounts receivable                       20,000
  Inventory                                 10,000
  Supplies                                   3,000
TOTAL CURRENT ASSETS:                    $  35,000

Now let’s add the other types of assets. These are “Property, Plant & Equipment” and “Intangible Assets“.

Property, Plant & Equipment
Land                                      $  5,000
Buildings                                  160,000                             
Equipment                                  200,000    
Less: acum depreciation                    (30,000)
NET PROP, PLANT & EQUIP                    335,000
Intangible assets
Goodwill                                   100,000
Trade names                                200,000
TOTAL INTANGIBLE ASSETS                    300,000
TOTAL ASSETS:                           $  670,000

Now that we have added all the assets together, go to the right side of the balance sheet. Record the liabilities – current and long-term.

LIABILITIES

Current Liabilities
   Notes Payable                         $  5,000
      Accounts Payable                     35,000
   Wages Payable                           10,000
       Interest Payable                     5,000
TOTAL CURRENT LIABILITIES                  55,000

Long-Term Liabilities
   Notes Payable                           50,000
   Bonds Payable                          500,000
TOTAL LONG-TERM LIABILITIES               550,000

TOTAL LIABILITIES                      $  605,000

After you have your liabilities, add the final portion of the balance sheet –  Owner’s Equity.

Owner's Equity

Common Stock                            $  50,000
Retained Earnings                          50,000
Less: Treasury Stock                      (35,000)
TOTAL OWNER'S EQUITY                    $  65,000

TOTAL LIABILITIES and OWNER'S EQUITY    $  670,000

Finally, you have added everything up. Now, verify if everything holds true to the accounting formula.

Assets = Liabilities + Owner's equity
$  670,00 = $  605,000 + $  65,000       
$  670,000 = $  670,000

Everything is balanced now, as it should be. If for whatever reason it does not end up balancing, then look back at all your numbers and make sure they are all correct. If you need help shaping your economics, then click here to download your free Know Your Economics guide.

Balancing the Balance Sheet

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Balancing the Balance Sheet

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Shareholders’ Equity Definition

Shareholders’ Equity Definition

The Shareholders’ Equity Definition is one of the three primary components of the balance sheet: assets, liabilities, shareholders’ (or owners’) equity. These three components comprise the well-known accounting equation of assets = liabilities + shareholders’ equity. This equation is important when beginning to think about what shareholders’ equity means for a business.

The owners’ equity category includes two things: investments into the company and retained earnings from each period. The investments can be from when the company launched and from later points in time. The important part is recording the investment under the shareholders’ equity section on the balance sheet. These two combine to fill the gap between the value of a company’s assets and liabilities. Using this logic, you can see how it is equally important to know the value of your assets, liabilities, and shareholders’ equity. If any component is incomplete or inaccurate, the financials will not be complete.

Shareholders’ Equity Example

For example Company A started with a $100,000 investment from the sole owner. In the beginning, the owner’s equity account is equivalent to the owner’s investment. After one year of business, the company has $60,000 in net profit. The owner decides to pay $10,000 in dividends and sends the other $50,000 to retained earnings. Thus, the owner’s equity account grew by the same amount as the retained earnings for that period.

When discussing shareholders’ equity, it makes a difference whether the company is private/public or mature/startup. Private companies often use separate terms for things like stocks, owners’ equity, and dividends. Public companies have more regulations and shareholders to please, so the financials of public companies usually look different than those of a private company. It is important to know whether a company is mature or a startup when looking at the financials. For example, if a startup has a very large retained earnings account under owners’ equity, something is either incorrect or extraordinary. Similarly, if a mature company’s shareholders’ equity is largely composed of owner investments and new partners’ investments, it could represent a struggling business. If the business is not creating enough net profit to reinvest into the company, it would have more owner investments than retained earnings.Shareholders' Equity Definition

See also:
Balance the Balance Sheet
Accounting Department Efficiencies
Balancing the Balance Sheet
Financial Assets
Current Liabilities

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Impact of FIT on Sustainable Growth Rate

The Institute of Fiscal Studies authored a study on tax systems in the UK called “Tax by Design: Mirrlees Review.” They concluded that “in the long-run, the tax system should be judged in part on its impact on the sustainable growth rate of the economy… viewing efficiency in a dynamic as well as static sense.” As we enter into tax season, you as the financial leader of your company should understand the impact of FIT on sustainable growth rate in your company.

What is Sustainable Growth Rate?

Sustainable Growth Rate (SGR) is the maximum amount of growth that an organization can sustain without increasing their financial leverage. It commonly suggests the percentage (%) growth in revenue that an organization can sustain with its current profit margin, earnings retention rate, leverage, and asset turnover.

Sustainable Growth Rate (SGR) = (1-d) x ROE

Dividend Payout Ratio (d) =  dividends / earnings

Return on Equity (ROE) = net income / shareholders’ equity

Even though there are numerous methods to increase your sustainable growth rate (such as increase the profit margin, asset turnover ratio, assets to equity ratio, or retention rate), the federal income tax can blindside you if you don’t prepare for it. FIT is unavoidable.

There are several economic theories concerning FIT, including the Laffer Curve and Reaganomics, that can be utilized to understand the impact of FIT on your SGR.

Laffer Curveimpact on sustainable growth rate

The Laffer Curve, created by Arthur Laffer, demonstrates the relationship between governmental tax revenue and tax rates. It important to understand this curve because at any given point on the curve, the amount of financial leverage you can supply to spur growth will differ.

If the tax rate is at Point A, then the government isn’t necessarily pleased by leaving your company with more dropping to the bottom line. This level of tax rates allows for your company to be more productive. Not only will you be able to breathe easier knowing you don’t owe the government so much, but your employees will be incentivized to work harder. They now know that their hard-earned money will land in their pockets. But having low tax rates isn’t always ideal. This is because your employees don’t have to necessarily work more to attain the “same” amount of “success” as they would at the Equilibrium Point.

If the federal income tax rate is at Point B, then both your company and your employees will question why should work be done. Since the government will be taking away 80-95% of revenue or income, the motivation to work will decrease significantly. At the point, your sustainable growth rate will be affected dramatically because the amount of financial leverage you have to spur growth is minimal. This point is typically seen in dictatorial economies.

Like in all things, there is an Equilibrium Point. This point allows for the government to make money as well as your company. Productivity remains high, allowing you more flexibility to provide growth in the company.

Although you cannot control the tax rate that the government has set, know how it impacts your company. One way to do this is by understanding the history of income tax rates.

Reaganomics

impact on sustainable growth rate

President Ronald Reagan called for widespread tax cuts during his presidential election in 1980. Within this economic plan, we saw four major factors:

  • deregulation of domestic markets
  • increased military spending
  • widespread tax cuts
  • decreased personal spending

The hope in implementing this plan was to reduce company’s expenses (primarily from tax expenses) to improve the economy as a whole. But as we saw with the Laffer Curve, there is a point when federal income taxes could be too low to improve the sustainable growth rate of a company.

Impact of FIT on Sustainable Growth Rate

In any company, cash is king. One of the major cash expenses that every company has is federal income taxes. Any tax strategy used to drive financial performance should not be considered as the end-all-be-all. The FIT reduces the amount of cash or financial leverage you have to increase your sustainable growth rate.

However, there are mechanisms or key performance indicators (KPIs) that you can utilize to focus on increasing your internal financial leverage. FIT is something that you cannot avoid. It will affect your sustainable growth rate. But by using a few indicators to measure profitability, etc, you’ll be better able to increase your SGR.

(NOTE: Want to start measuring your company’s KPIs today? Check out our KPI Discovery Cheatsheet!)

When calculating your sustainable growth rate, it’s important to recognize that any positive rate can allow for growth. It’s imperative to calculate FIT when you’re expecting or desiring growth.

Sustainable Growth Rate (SGR) = (1-d) x ROE

ROE (net income / shareholders’ equity) should have your FIT factored in. It’s easy to forget this important step until you find your wanting to utilize your internal financial leverage and you lost 35% of profit, severely reducing the financial leverage that you thought you had. Know the impact that the federal income tax has on your sustainable growth rate.

If you want to track your sustainable growth rate, then download your KPI Discovery Cheatsheet today.

impact of FIT on sustainable growth rate

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Shareholders Equity

See Also:
Return on Equity Analysis
Return on Common Equity (ROCE)
Retained Earnings
Balance the Balance Sheet
Return on Equity Example

Shareholders Equity Definition

Shareholders equity is an essential part of the accounting equation: Shareholders Equity = Total Assets – Total Liabilities. It is the difference between the value of a company’s assets and liabilities. This does not mean that every company has a shareholders equity account with money in it, yet it does mean that every business has this account on the balance sheet. This is because shareholders equity comes from the shareholders’ investments into the business and from retained earnings. In new companies, a large portion of this equity comes from the owners’ initial investments. In a more mature-stage company, retained earnings is often the majority of shareholders equity on the balance sheet.


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Retained Earnings

Retained earnings is one of the two components that make up Shareholders Equity. It is simply the net income that a business does not distribute to its shareholders. This account is listed underneath Shareholders Equity and is closed out after each period.

As mentioned, dividends are taken out of net income before going into the retained earnings account. The decision to pay dividends is affected by taxes and the required reinvestment for the next period. Distributing less or more affects a company’s taxes as well as the shareholders’ taxes. By paying out large dividends, a company can minimize its takes due. This transfers the tax liability to the shareholders. Keeping net income to reinvest into the business also has tax implications. Holding onto cash rather than paying dividends results in higher taxes.

Return on Equity

Return on equity (ROE) is a term to describe net income as a percentage of shareholders equity. In other words, return on equity is net income / shareholders equity. This percentage shows how efficient a company is at using shareholders equity to create a profit. When looking at a company, examining its return on equity over the last several years can show the true growth of a company. ROE is a fast indicator of sustainable growth, since net profit is the ‘organic’ way to reinvest into a company. For this reason, many refer to ROE as the sustainable growth rate.

Calling return on investment sustainable growth rate is helpful in planning cash needs. If a business has a ROE of 10%, then it knows that it can reinvest and grow 10% that year without outside investment. This can be very helpful for investors. If an entrepreneur shows a business plan with a projected 30% annual growth, sustaining a 15% ROE, and has no plans for outside investment, then he or she will inevitably have cash flow problems. Additional funds make up the disparity between the 15% and 30%. Being cognizant of a business’s sustainable growth rate helps plan for future cash flow problems. After all, underestimating cash needs is one of the top reasons for businesses that fail.

Shareholders Equity

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Return On Equity Example

Return On Equity Example

A return on equity example – Melanie, after seeing success in her corporate career, has left the comfortable life to become an angel investor. She has worked diligently to select companies and their managers, hold these managers accountable to their promises, provide advice and mentoring, and lead her partners to capitalization while minimizing risk. At this stage, Melanie is ready to receive her pay-out. As a result, Melanie wants to know her Return on Equity ratio for one of her client companies.

So, Melanie begins by finding the net income and average shareholder’s equity for the venture. Looking back to her records, Melanie has invested $20,000 in the business. Her net income from it is $6,000 per year. Performing her return on equity analysis yields the following results:

Return on equity: $6,000 / $20,000 =30%

Melanie is happy with her results. Purposefully starting small, she has built the experience and confidence to be successful. She can now move on to bigger and better deals.

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return on equity example

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See Also:

Return on Common Equity (ROCE)
Return on Equity (ROE)

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Return on Equity Analysis

See Also:
Financial Ratios
Return on Asset
Required Rate of Return
Return on Invested Capital (ROIC)
Debt to Equity Ratio
Return on Common Equity (ROCE)
What The CEO Wants You to Know How Your Company Really Works

Return on Equity Analysis

Defined also as return on net worth (RONW), return on equity reveals how much profit a company earned in comparison to the money a shareholder has invested.

Return on Equity Explanation

This term is explained as a measure of how well a company uses investment dollars to generate profits. Return on equity is more important to a shareholder than return on investment (ROI) because it tells investors how effectively their capital is being reinvested. Therefore, a company with high return on equity is more successful to generate cash internally. Investors are always looking for companies with high and growing returns on equity. However, not all high ROE companies make good investments. The better benchmark is to compare a company’s return on equity with its industry average. Generally, the higher the ratio, the better a company is.

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Return on Equity Formula

The following return on equity formula forms a simple example for solving ROE problems.

Return on Equity Ratio = Net income ÷ Average shareholders equity

When solving return on equity, equation solutions only form part of the problem. Thus, one must be able to apply the equation to a variety of different and changing scenarios.

Return on Equity Calculation

Average shareholders’ equity, or return on equity, is calculated by adding the shareholders’ equity at the beginning of a period to the shareholders’ equity at period’s end and dividing the result by two. Unfortunately, no simple return on equity calculator can complete the job that a solid understanding of ROE can.

For example, a company has $6,000 in net income, and $20,000 in average shareholders’ equity.

Return on equity: $6,000 / $20,000 =30%

In conclusion, a company that has $0.3 of net income for every dollar that has been invested by shareholder.

Return on Equity Example

Melanie, after seeing success in her corporate career, has left the comfortable life to become an angel investor. She has worked diligently to select companies and their managers, hold these managers accountable to their promises, provide advice and mentoring, and lead her partners to capitalization while minimizing risk. At this stage, Melanie is ready to receive her pay-out. Melanie wants to know her Return on Equity analysis ratio for one of her client companies.

Melanie begins by finding the net income and average shareholder’s equity for the venture. Looking back to her records, Melanie has invested $20,000 in the business. Her net income from it is $6,000 per year. Performing her return on equity analysis yields the following results:

Return on equity: $6,000 / $20,000 =30%

Melanie is happy with her results. Because she was purposeful and started small, she built the experience and confidence to be successful. She can now move on to bigger and better deals.

If you’re looking to sell your company, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

return on equity analysis

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Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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