When you look at the balance sheet that the accountants from an accounting firm in Johor Bahru prepared for you, you will see three sections, which are the assets, liabilities and shareholder’s equity. When it comes to the analysis of the balance sheet, some may think that they only need to analyse the assets if they want to know the financial position for that company. On the other hand, others think that analysing the liabilities is more crucial. Most people will underestimate the importance of the analysis of equity. However, equity is also an important part that makes up the accounting equation and should not be ignored.
Equity indicates the amount of capital that the company’s shareholders have contributed to the business. To calculate the sum of equity, one may modify the accounting equation, which states that the company’s asset is equal to the sum of its liabilities and equity. By altering the equation, business owners can calculate the equity of their business by subtracting liabilities from total assets.
A few ratios can be very helpful if business owners want to analyse the shareholder’s equity of their company. The first one that we are going to discuss here is the debt to equity ratio. To calculate this ratio, one should divide the company’s long-term debts with the shareholder’s equity. This ratio helps the investors, stakeholders and of course, the business owners to understand the proportion of equity of the company when compared to its debts.
For instance, XYZ Corporation has a debt to equity ratio of 1.5. This means that its debt is higher than its equity, which may not be a good sign to the business owners and the investors. The lower this ratio is, the more stable the company is. Hence, companies with a high value of debt to equity ratio may bring more risks to the company’s creditors and investors.
Apart from that, the return on equity (ROE) is also a crucial determinant. It presents the way the company handles the capital that the shareholders have invested. To calculate the ROE, one should divide the company’s net income by equity. Higher ROE indicates that the company is using the funds injected efficiently. Hence, high ROE value is undoubtedly a piece of good news to the shareholders.
As an example, the value of ROE for ABC Corporation is 60%. This means that ABC Corporation has generated a profit of RM0.60 for every ringgit the shareholders have invested.
In short, business owners should not leave out the equity section when they are analysing the balance sheet of their business. The ratios and calculations regarding the company’s equity are also crucial for them to understand its actual financial position.