Shareholders' equity originates from two important sources: contributed capital from shareholders in exchange for shares of common and preferred stock, and the undistributed net income that the company has earned since its inception. Business activities that occur each day, such as the sale of merchandise or the sale of stock, may have a direct or indirect contribution to shareholders' equity.
When a corporation's revenues exceed its expenses, the net income is retained by the corporation in the shareholder equity account "retained earnings," presented on the company's balance sheet. The cumulative, undistributed net income that makes up the retained earnings balance may be distributed to shareholders in the form of a dividend, and may also be reinvested back into the corporation to fuel growth strategies and to maximize shareholder wealth.
When a corporation implements a price increase on its goods or services, the increase will yield a higher operating profit, ultimately resulting in an increase to shareholder's equity. Since business owners may risk losing customers from the increased prices, a business may choose to increase the price on only its high-volume products or offer a tiered pricing structure to its customers.
Issue Shares of Stock
Stockholders' equity comprises the capital contributed by both its common and preferred shareholders, so the issuance of shares results in an increase to a corporation's equity balance. Since equity capital may not require payments of interest to shareholders, this form of capital is a common form of corporate financing. When reading the equity section of a corporation's balance sheet, the investor must remember that shareholders' equity is increased by the number of outstanding shares.
Other activities that may contribute to shareholders' equity include implementing a company-wide budget for all employees that may reduce paid-time off holidays and vacations, and reducing the hours required from its hourly employees. Shareholders' equity may also be increased by restricting company travel and entertainment to only necessary travel required of select employees, and other budgeting measures.
- Comstock/Comstock/Getty Images