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Just stated learning about financial statement it is the tough, lots of calculations and stuff. I came across some balance sheets, read some online resources but I still can't grasp the idea of why there's a column called shareholder's equity which includes common stocks,retained earnings... and few numbers there.

My questions are what does this mean ? is that considered a liability ? For example some resources I read says this is the firms total (equity financing) is that right ? if so is it considered a liability just like a debt ?

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Shareholder's Equity consists of two main things: The initial capitalization of the company (when the shares were first sold, plus extra share issues) and retained earnings, which is the amount of money the company has made over and above capitalization, which has not been re-distributed back to shareholders.

So yes, it is the firm's total equity financing-- the initial capitalization is the equity that was put into the company when it was founded plus subsequent increases in equity due to share issues, and retained earnings is the increase in equity that has occurred since then which has not yet been re-distributed to shareholders (though it belongs to them, as the residual claimants).

Both accounts are credited when they increase, because they represent an increase in cash, that is debited, so in order to make credits = debits they must be credits. (It doesn't mean that the company has that much cash on hand, as the cash will likely be re-invested).

Shareholder's Equity is neither an asset nor a liability: it is used to purchase assets and to reduce liabilities, and is simply a measure of assets minus liabilities that is necessary to make the accounting equation balance:

Shareholder's Equity = Total Assets - Total Liabilities

Since the book value of stocks doesn't change that often (because it represents the price the company sold it for, not the current value on the stock market, and would therefore only change when there were new share issues), almost all changes in total assets or in total liabilities are reflected in Retained Earnings.

  • Why isn't the retained earnings always distributed back to the shareholders? Isn't it technically their money? Dividends make up only a small portion of this retained earnings. – Novel Ventures Dec 30 '18 at 0:03
  • In general, the market value of a shareholders shares will rise to more than cover retained earnings, so the theory is that shareholders shouldn't have to care about dividends at all-- if a shareholder wants to take their money out all they need to do is sell off some shares. From a more pragmatic perpective, CEOs would prefer to keep the money to give themselves flexibility to run the company. If retained earnings were returned to shareholders every single investment/expansion/restructure would require an investment round, giving shareholders and new investors a lot of power. – serakfalcon Dec 30 '18 at 0:58

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