Corporate organizational structures are ever evolving when it comes to modern businesses. In the past there were plenty of small scale family owned businesses, however this has rapidly changed with the increase of multinational companies expanding rapidly throughout the world. Capital is usually a big problem for most companies.
This has made companies look for avenues of funding to expand operations. One of the most popular ways to raise finance has been through the listings of the companies on the stock markets. Therefore ownership of most companies is held by a number of individuals and investment institutions who all have the common goals of growing the company at the same time maximising profits. As a control measure and part of good corporate governance all companies that have member equity are expected to publish their financial statements to the shareholders every year.
One of the most important things published in the financial statement is the balance sheet. Investopedia defines the balance sheet as a financial statement that summarizes a company’s assets, liabilities and shareholders equity at a specific point in time. These three segments give an idea about the financial state of the company. The balance sheet must have the following formula assets=liabilities together with share holder equity. There are a number of implications about this equation. Ideally this equation should at least balance to ensure stability. This does not always happen.
Using an example of a company that has total assets worth $100 000, liabilities worth $30 000 and $50 000 of shareholder equity. When such a situation occurs then the company has a clean bill of health. This is because the company does not owe anyone money because it has a positive balance of $20 000.Most shareholders will be happy about the financial state of the company and the board can even later go on and declare dividends.
On the other hand a company can fall on really bad times due to a number of both external and internal economic factors. Using the earlier example of a company with assets worth $100,000, liabilities of $50,000 and $60,000 of shareholder equity. In such a case the company is said to be operating with a member’s equity deficit. If such a case happens then the company is not in good financial health, this is because it cannot cover all its member equity. This would not usually please most of the shareholders. This is because if all the members were to request their equity back then the company would be unable to pay back all the money.
When such a situation occurs some members can lose confidence in the company and this can be seen by the selling of shares or the pressure to fire the board members. On the positive as long as a company has a good business model this member equity deficit can be wiped out. In some cases this deficit can also be caused by buying into a new market which leads to a lot of debt in the short run.