Tangible Common Equity (TCE)
What it is:
How it works (Example):
The formula for tangible common equity is:
Tangible Common Equity = Common Equity - Preferred Stock - Intangible Assets
Let's say Company XYZ has $40,000,000 of total assets and $25,000,000 of total liabilities. It has no preferred stock, but it does have a $3,000,000 line item for goodwill and $2,000,000 worth of trademarks.
First, we can calculate common equity by subtracting liabilities from assets: $40,000,000 - $25,000,000 = $15,000,000.
Then we can use the formula above to calculate Company XYZ's tangible common equity:
TCE = $15,000,000 - $0 - $5,000,000 = $10,000,000.
Goodwill is an accounting construct with no marketable value and trademarks cannot be easily separated from the company and sold piecemeal, so these two intangible assets are subtracted from common equity to calculate tangible common equity.
Few intangible assets have liquidation value. There is one important exception: patents may indeed have value during a liquidation and are thus generally not included in "intangible assets" when calculating tangible common equity.
Why it Matters:
Equity, in general, is the difference between a company's assets and liabilities. Intuitively, if all the assets are sold and all the debts are repaid, common equity represents what's left over for company shareholders. However, intangible assets usually aren't worth much to anyone outside of the firm, even though they may contain tremendous value for their owners. So we back them out of the tangible common equity calculation in order to gauge the true liquidation value of a firm.