What is Average Shareholders’ Equity?

Average shareholders' equity is an averaging concept used to smooth out the results of the return on equity calculation. This concept yields a more believable return on equity measurement. The concept is most useful when measuring the return on investment in a period in which a business has sold a large amount of stock. In this case, the ending shareholders' equity figure will be much higher than the beginning figure, which results in a substantially lower return on equity calculation. If there are few stock sales over time, this means that a trend line of return on equity measurements will reveal a sharp dip in any period in which stock is sold, even if the overall returns of the business are approximately the same over time.

How to Calculate Average Shareholders’ Equity

The average shareholders' equity calculation is the beginning shareholders' equity plus the ending shareholders' equity, divided by two. This information is found on a company’s balance sheet. The resulting formula is:

(Beginning shareholders' equity + Ending shareholders' equity) ÷ 2 = Average shareholders’ equity

The concept may be built directly into the return on equity formula, where the average is stated in the denominator, as follows:

Net income ÷ ((Beginning shareholders' equity + ending shareholders' equity) ÷ 2) = Return on equity

Example of Average Shareholders’ Equity

The controller of Deliberate Enterprises wants to calculate the entity’s return on equity. To do so, she finds that the beginning shareholders’ equity for the business was $2,400,000, while its ending shareholders’ equity was $3,000,000. Based on this information, she concludes that the firm’s average shareholders’ equity was $2,700,000 for the period. Her calculation was as follows:

($2.4 million beginning equity + $3.0 million ending equity) ÷ 2 = $2.7 million average shareholders’ equity