Friday, 10 August 2012

Balance Sheet Pt-4

Shareholder Equity :

In this article we will learn about Shareholder Equity a little more. In the last article we had noted that when a company is liquidated, the shareholder equity will equal the net worth of the company. There are other aspects of shareholder equity too which are as follows.

The shareholder equity of any normal company equals the retained earnings (minus any dividends paid), share capital, premium shares, over par value shares etc. Whenever distribution of shareholder equity occurs, then preferential shareholders who have been given shares at a premium will get preference over common shareholder.

Preferential shareholders are those individuals or institutions which are given shares of the company by the promoter to raise capital. Generally the price of such shares will be over and above the prevailing market price.

Common shareholders are the other shareholders who have bought shares of the company through the stock exchange at prevailing market price.

The parameter of shareholder equity is important to understand another important term. The Debt/Equity ratio.

Debt/Equity Ratio :

To explain with an example, if a company has a funding structure with a loan of Rs.50,000 and an equity of Rs.1,50,000 then its Debt/Equity ratio is ⅓. It means, that for every 3 rupees the company has a debt of 1 rupee. A low debt/equity ratio is always good because it means that the company has enough funds to service whatever little debt it has and also some more for its growth and expansion plans.

As a stock investor we should always try to know whether a company is able to adequately service its debt and raise equity so that it can go forth with its expansion plans. The debt/equity ratio gives a quick glance into this aspect of the company.