Shareholders listed on the balance sheet is used by investors to determine the financial health of a company.
Equity is the amount that will be returned to shareholders if all assets were liquidated and all debts repaid. In short, measures the share capital the net worth of the company.
The company’s share capital shall be calculated as follows:
Total Assets – Total Liabilities = Equity
The negative balance in the composition of shareholders ‘equity, also called shareholders’ equity, means that liabilities exceed assets and it can be caused by several reasons.
The Reason Of Negative Own Capital
Accumulated losses over several periods or years can lead to negative equity. In equity the balance of retained earnings is the balance of the profits or net income that is used to pay dividends, reduce debt or reinvest in the company.
In the case of a net loss, the loss is transferred to retained earnings as a negative number and deducted from any balance retained earnings from previous periods. As a result, negative equity may mean that the company has suffered losses in several periods, so that the existing retained earnings, and any funds received from issue of shares has been exceeded.
Large dividend payments that have either been exhausted or retained earnings exceeded equity will show a negative balance. Combined financial losses in subsequent periods after large dividend payments could also result in a negative balance.
Borrowing money to cover accumulated losses, instead of issuing more shares at the expense of own funds can lead to negative shareholders. As a rule, funds obtained from the issue of shares will generate a positive balance of equity. As noted earlier, financial losses that could accumulate equity will show a negative balance, and any outstanding balance will show as a liability. In other words, the company can cover these losses through borrowings, equity capital would have a negative balance.
Amortization of intangible assets, such as patents or trademarks, is recorded in the equity section and may exceed the existing balance of equity. In amortization of intangible assets is a process of writing off the cost of intangible asset over the projected life of the asset.
Negative equity can be a warning sign that the company is in financial difficulty, or it could mean that the company has spent its retained earnings and funds from issuing shares to reinvest in the company through the acquisition of expensive machinery and equipment. In other words, negative equity should tell the investor to dig deeper and explore the reasons for the negative balance.
Read more about the balance, please read how to do the income statement and balance sheet differ?