What Is Non-controlling Interest? (And How to Calculate It)
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If you work in finance, you may encounter the terms non-controlling interest or minority interest. The terms are interchangeable and apply to parent companies that own a subsidiary. Understanding the non-controlling interest and what it entails can help you produce accurate financial statements. In this article, we define non-controlling and controlling interest, calculate minority interest, discuss its advantages, and give some examples to help you understand the concept.
What is non-controlling interest?
Non-controlling interest (NCI), also known as minority interest, is when an investor owns less than 50% of a company. As the investor has less than 50% ownership, they can't make company decisions or exert control over it. Instead, whoever has over 50% ownership, typically the business owner or parent company, can make all the decisions as they have enough votes to be the majority.
Minority interest allows business owners to receive funding from investors without relinquishing any control. It also helps companies take less of a risk when purchasing a subsidiary. As a parent company only needs 51% ownership to control the subsidiary, selling the rest to investors puts less capital at risk of loss if the subsidiary company isn't successful. There are two types of minority interest, direct and indirect. Consider the following explanation of each to help you understand the concept better:
Direct minority interest: Direct NCI, or direct minority interest, is when non-controlling investors receive a portion of the profits the company receives pre- and post-acquisition.
Indirect minority interest: Indirect NCI, or indirect minority interest, is when non-controlling investors only receive profit post-acquisition.
What is controlling interest?
Controlling interest is when an investor owns over 50% of a company but not 100%, allowing the investor to control the company as their vote is the majority. Individual investors rarely have controlling interest as it is more difficult for them to purchase over 50% of a company's shares. Instead, parent companies that acquire a subsidiary tend to be controlling interest holders.
Calculating minority interest
Calculating minority interest is typically most relevant for parent companies that own a subsidiary. When the parent company wants to calculate the subsidiary company's earnings, it accounts for the percentage going to investors. This means the parent company incorporates the impact of the subsidiary's minority interest on its balance sheet and income statements. You can calculate the minority interest of a company's balance sheet and income statement by following these steps:
Calculating minority interest of a balance sheet
Follow these steps to calculate minority interest of a balance sheet:
1. Find the book value
Start by finding the book value of the subsidiary, which is the net difference between a company's total assets and liabilities. The book value is different from a company's market value, which is typically higher. This is because successful companies often have more earning power and continue to grow, making them a good investment. To find the book value of a company, also known as the net asset value, look at the subsidiary's balance sheet.
A balance sheet is one of the most common financial statements. It reports a company's assets, liabilities, and shareholder equity at a specific time, such as a previous quarter or year. Essentially, a balance sheet shows how much a company owns and owes, which can be helpful for potential investors to decide whether to invest and how much. A parent company typically has one balance sheet, which also has the subsidiary's earnings on it.
2. Multiply the book value by the ownership percentage
Once you have the book value, you can multiply it by the percentage of ownership minority shareholders have of the company. For example, if a subsidiary's book value is $500,000 and minority shareholders own 30% of it, here's what the equation may look like:
30% × $500,000 = $150,000
This means the minority interest is $150,000. You can note this amount on the balance sheet in the equity section as its own entry or a non-current liability.
Calculating minority interest of an income statement
To calculate the minority interest of an income statement, follow these steps:
1. Compute the net income
Use the information from the company's income statement to determine the net income of the minority interest owners. To do this, you need the subsidiary's net income. Net income, also known as net earnings, is the revenue minus the expenses, interest, and taxes. For example, if the company earned $50,000 in sales last year, it didn't keep all that money because a portion of it went towards paying for expenses like rent, supplies, and labour. Calculate the company's net income yourself or look for it on a recent income statement.
An income statement, or profit and loss statement, is another common type of financial statement. It includes the following information about a company's revenue and expenses:
Revenue: This is the amount of money the company received, typically from sales, during a specific period.
Gains: This is an increase in the value of the company's assets and property. For example, if the company sells real estate for a higher amount than the money used to purchase it.
Expenses: This is the money the company had to spend to operate effectively. For example, money spent on rent, utilities, employee wages, supplies, or interest.
Losses: If the company lost any additional money, the income statement might also reflect this. For example, if a customer sued the company, the money spent on the lawsuit is a loss.
Net income: This is the amount of money the company has left over after subtracting its expenses and losses from its revenue and gains. Net income is the number you're looking for to calculate minority interest.
2. Multiply net income by the minority interest percentage
Once you know a company's net income, you can multiply it by the minority interest percentage. This is the percentage of the company investors own. For example, if investors owned 40% of a company that had a net income of $125,000 last year, here's what the equation may look like:
40% × $125,000 = $50,000
This means $50,000 of the company's net income goes to its investors. Once you know this number, you can place it on a non-operating line item on the company's income statement to note the loss.
Advantages of minority interest
If you're deciding whether to become a minority interest holder, you may want to know the advantages of doing so. Here are some benefits you can enjoy if you have minority interest in a company:
You remain up to date with the company's operations, enabling you to plan your investments accordingly.
You have access to the company's financial books, so there's transparency.
You have the potential to earn a profit without having to put much work into the company.
It's fairly simple to sell your company shares if you're no longer interested in being a minority holder.
It's typically a low-risk investment, as you won't have much stake in the company.
Examples of minority interest
To help you fully understand minority interest, consider the following examples:
Here's an example of what minority interest may look like using the net income method:
Evergreen Cameras wants to acquire Picture Perfect, a film camera company. Picture Perfect is willing to sell 70% of its shares to Evergreen Cameras because the owner wants to keep 10%, and current investors already own 20%. Evergreen Cameras agrees and purchases the shares. In its first year of business under new management, Picture Perfect earns a net income of $150,000.
This means Evergreen Cameras gets $105,000 (0.70 × 150,000 = 105,000), the original owner gets $15,000 (0.10 × 150,000 = 150,000), and the original investors get $45,000 (0.30 × 150,000 = 45,000). Evergreen Cameras then includes the $105,000 on its balance sheet and income statement.
Here's an example of what minority interest may look like using the balance sheet method:
A clothing store, Jewel Clothing, is going out of business, so the owner decides to sell the company. A department store, Marsha's, wants to buy 80% of the shares, and an individual investor wants to buy the other 20%. Jewel Clothing's book value for the first year under new management is $175,000. This means Marsha's earns a profit of $140,000 (0.80 × 175,000 = 140,000) and the investor earns $35,000 (0.20 × 175,000 = 35,000). Marsha's then includes the $140,000 on its balance sheet and income statement.
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