Equity on the Balance Sheet

We have looked at a company's balance sheet in several previous tutorials such as here, but we have largely focused on the assets and liabilities sections within. The third section is equity, which - although doesn't contain as much relevant information - does contain points that are worth understanding. Indeed, trends in several figures are actually quite enlightening about the history of the company and can actually hint at traits of company management, such as their willingness to issue equity. However, we must first understand what equity on the balance sheet represents.

The Structure of the Equity Section

The equity section of the balance sheet varies across the company looked at and generally becomes more complex as the size of the company looked at grows. Consequently, large multi-national companies like Rolls-Royce are likely and mostly do have far more complex equity sections than  smaller, single-country companies.

That said, the range of components within an equity statement is relatively small, and there are some components that are common across almost all balance sheets. A short list of some of the most common equity components are shown and briefly explained below.  Most of these terms don't need to be worried about so we will look at the trends of those components that are important in a section later. The three most common components have their font in red bold.

For reference purposes, the nominal value of a company's share is a value at which it cannot legally issue shares below, unless the company undergoes a 'Capital Reorganisation/Reduction'. As an example, if a company trades at 200p/share and has a nominal value of 100p/share, it cannot issue any paid-for shares below 100p.

Share Capital: This is the total, in £GBP, of all the cash raised by the company at the nominal value. For example, if a company is trading at 150p raises £500,000 at its nominal value of 100p, then the share capital within the equity portion of the balance sheet will increase by £500,000

Share Premium: This section is relevant if shares are issued above the nominal value. The share premium is the total, in £GBP, of all cash raised above the nominal value. For example, suppose there is a company trading at 150p and it has a nominal value of 100p. If it raises £600,000 at 150p, then this is above the nominal value. So we split the £GBP proceeds between Share Capital and Share Premium.

Basically, to raise £600,000 at 150p, 400,000 new shares need to be issued. Each of these 400,000 shares will have a nominal 100p and a premium of 50p. So we record the Share Capital as increasing by (400,000*£1) = £400,000 and the Share Premium as increasing by (400,000*£0.50)=£200,000.

The cost of a share issue is usually subtracted from here too. So if the above (example) share issue cost £50,000 to organise, then the recorded Share Premium figure would drop down to £150,000.

Retained Earnings/Losses: This is the sum of all after-dividend profits/losses that the company has incurred since inception. However, if there is a reverse takeover, then this number will remain on the balance sheet.

For example, suppose a company has been trading for 2 years. In year 1 the company made a post-dividend profit of £100,000 and in year 2 the company made a post-dividend profit of £20,000. Then the Retained Earnings will be shown as £120,000.

Noncontrolling Interests: This is similar to Retained Earnings/Losses but is for non-controlling interests. All profits due to non-controlling interests are accumulated within this section

Merger Reserve: The Merger Reserve is the £GBP value of any shares above the nominal value of the shares, given during an acquisition/merger with another company. Think of it as the share premium that is specific to a share-based acquisition.

Capital Redemption Reserve: This arises when a company purchases its own shares in a share buy-back scheme. The £GBP amount of shares purchased is put into the Capital Redemption Reserve.

Share-based Payment Reserve: This reserve describes the total amounts recognised reflecting the fair value of share options granted

Foreign Exchange Reserve: This reserve accumulates all the gains or losses that have arisen from foreign exchange movements over the period. This foreign currency translation is sometimes included in the Retained Earnings/Losses line hence it does not always have its own line.

Consolidated Statement of changes to Equity

Within all financial statements we are presented with a statement of changes to equity over the period. This outlines the various movements for each reserve section and tells us a few things. If we look at the image above, the opening figures for the start of the period are shown across the line "As at 1 January 2014" and the closing figures are shown across the line "As at 30 June 2014". Since six months are covered, we are clearly looking at a half-year report.

So what can we tell from the movements?
  -  At the start of 2014, the company had raised previously ~$6.6m from historic share issues. This is the opening Share Capital figure plus the opening Share Premium figure.
  -  The company raised $1.022m during the half-year. Since it is in dollars, it may not exactly correlate if you try to work it out manually since it will have been recorded using the foreign exchange rate at the time. The cost of that equity issue was $108,000.
  -  The company generated a post-tax loss of $442k during the half-year
  -  There was a foreign exchange loss of $239,000. This tallies with the line on the income statement as per the image below.

Now that we understand what equity represents, in the next tutorial we will look at interesting trends that can be seen from these figures.