Question

Begin by reviewing the labels for the change in​ stockholders' equity and then enter the amounts for each situation​

		2017		2016
Total assets	$	80	$	47
Total liabilities		17		21

Answer 1

Stockholders' equity is generally calculated using the formula Total Assets- Total Liabilities . The said annotation of assets and liabilities is referred to the ones that exist as at the end of concerned financial year.

Here in the given question as the figures of total assets and liabilities are given, we can calculate Stockholders' equity for both the years using the above formula.

So, 2017 2016

Stockholders' Equity $80-$17=$63 $47-$21=$26

In the above case, we can see that the stockholders' equity has increased more than double in 2017 when compared to 2016, now let us see what really causes the stockholders' equity to increase?

There are two main reasons for rise in stockholders' equity and they are -

1. Retained Earnings -  

"From an investor's perspective, the most encouraging sign of business success is that it earns a profit. However, not all profitable companies have their stockholder equity go up. What a company chooses to do with its profits will determine whether stockholder equity will rise.

If a company chooses to hold onto its profits and either hold them as cash or use them to invest internally in its business, then stockholder equity will go up. That's because the earnings of the business will cause the value of cash or other assets to rise without any corresponding increase in the company's liabilities. The company's Retained Earnings line item will rise on its balance sheet, and that figure directly feeds into overall stockholder equity.

By contrast, if a company pays out all of its profits to shareholders as dividends, then stockholder equity won't change. The rise in cash from the company's earnings will be offset by the use of that cash to pay dividends, and there will be no net change in retained earnings."

2. Raising Capital -

"The other situation in which stockholder equity goes up is when a company obtains additional equity financing by selling stock. The sale of shares increases the amount of cash that the company has, but it doesn't create a new liability. Instead, the proceeds from the stock sale are typically split between the Common Stock line item and the Additional Paid-In Capital on Common Stock line item, according to how much of the proceeds are allocable to the par value of the newly issued shares versus any excess over par value."

Now that we have seen, what causes an increase in stockholders' equity, now let us see what are the possible consequences of such rise?

1. Shareholders add more capital

Investors choose companies that they believe will see their value rise over time. The most tangible indicator of whether a company is becoming more valuable is how much it reports in stockholders' equity on its balance sheet.

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When a business first starts out, its owners typically make capital contributions to get it off the ground. Sometimes, business owners lend money to their business, but typically, they also agree to make investments in exchange for their proportional ownership of the stock of the business.

This second type of capital contribution increases stockholders' equity. If an owner loans money to the business, then the liability for the debt balances out the cash the business receives as an asset, leading to no change in stockholders' equity. With a traditional capital contribution, however, there's no increase in any liability item, leaving stockholders' equity to receive the benefit of the amount of money invested.

Even once a company goes public, transactions that act as capital contributions can boost stockholders' capital. For instance, in a secondary offering of stock, the company sells shares in exchange for cash. The cash proceeds, less any expenses related to the offering, boost the company's assets and in turn create an increase in stockholders' capital as well."

2. Turning a profit

"The other primary way that stockholders' equity changes is when the business makes a profit. However, it's not enough that the company make money. It also must choose to hold onto its profits, rather than paying them out as dividends."