Of all the financial statements, the balance sheet may be deemed the most important if for no other reason than almost all other statements support it, rely on information that the balance sheet presents or, in some way, provide information that's reported in it.
The balance sheet is an annual record of a company's financial condition. Two elements of this document that reflect a company's financial state are total equity and net tangible assets.
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What Is Total Equity?
Total equity, or shareholder equity, is equal to a company's total assets minus its total liabilities, both of which are documented in an organization's balance sheet. Whereas the total asset value is the sum of current and noncurrent assets, total liabilities is equal to current liabilities plus long-term liabilities.
Consequently, total equity represents a company's net value which, when a positive number, equates to the cash that will be distributed to a company's shareholders should the business liquidate its assets to pay organizational debts.
The Importance of Total Equity
In this way, total equity represents the residual claim of a company's shareholders to the company's profits. If the company's total assets equal or exceed its total liabilities, the company has the assets needed to pay its debts. If, however, total equity is a negative number and that state remains unchanged for the long term, the company is insolvent, or unable to pay its creditors the amounts it owes them when the debt is due.
An investor may consider a company with a negative shareholders' equity as a risky investment. Even so, the shareholders' equity value in and of itself may not reflect a company's true financial health. To accurately gauge a company's financial standing, other tools and metrics are needed.
What Are Net Tangible Assets?
Total tangible assets minus the sum of liabilities, intangible assets and the par value of preferred stock is the formula used to calculate net tangible assets. Consequently, net assets convey the value of a company's physical assets less its outstanding debt.
Shareholders take note of net assets in that the figure represents a difference between what a company owes and the assets it owns which have a financial value. A company whose assets exceed its liabilities has "positive net assets," so it's a financially healthy company. Because its assets exceed its debt, the company can relieve a portion of its debt burden when it needs to by selling some of its assets. By paying off debt, it might be in a position to refinance other debt to acquire a lower interest rate.
Conversely, if the firm's liabilities exceed its assets, it's experiencing financial difficulties. To make matters worse, it has no assets it can sell to gain the cash it needs to relieve some of its debt burdens. What's more, the company's financial situation may suggest the company should instigate a Chapter 11 bankruptcy.
Total Equity and Net Assets Example
An example may help you understand the concepts of total equity and net assets:
Assume that company A has assets that total $240 billion, liabilities of $165 billion, goodwill of $35 billion and no preferred stock. In this case, to calculate company A's total equity, you subtract $165 billion liabilities from $240 billion assets, which equals $75 billion total equity. In turn, company A's net assets equal total assets of $240 billion minus $35 billion goodwill and $165 billion liabilities, or $40 billion net assets.
It's important to note that total equity accounts for company A's $35 billion goodwill, an intangible asset, but net assets does not.
A balance sheet, or a statement of assets and liabilities, illustrates a company's financial condition as of a certain date. The balance sheet classifies and measures a company's assets, liabilities and owners' equity for a particular time, which is typically a fiscal year. The balance sheet is the basis for many metrics, including total equity and net assets.