NEW YORK (CNN/Money) - When the stock market dropped in 2000 through 2002, I understand that companies lost market value from the investors' point of view. But wouldn't the money investors originally invested still show in the companies' financial records? Did the value of the companies really decline?

-- Randall, San Angelo, Texas

All right, you're mixing up two concepts here -- shareholders' equity and market value or, as it's better known among investors, market capitalization, aka, market cap. Let's see if I can clear things up.

Shareholders' equity is an accounting measure. An accountant totes up the value of what a company owns (its assets), subtracts what it owes (its liabilities) and the difference is the company's net worth, or what is owned by the shareholders -- shareholders' equity. For example, at the end of 2003, Microsoft (MSFT: Research, Estimates) had shareholders' equity of $69.3 billion.

When a company first starts out, its shareholders' equity consists entirely of the money the original investors put into the firm, either privately or through an IPO, or initial public offering of stock.

If the company operates at a profit, it's shareholders' equity grows. You can usually see that growth by comparing the "retained earnings" portion of shareholders equity year to year on a firm's balance sheet.

While the concept of shareholders' equity is pretty straightforward, it doesn't always reflect the actual value of what shareholders' own.

In the accounting world, for example, real estate is carried at its original cost minus depreciation. In the real world, however, real estate is usually an appreciating asset.

So a building carried at, say, $1 million on the books might actually be worth $10 million. If that's the case, then shareholders' equity in the accounting sense is probably understating shareholders' equity in the real world.

There are plenty of other issues that are basically judgment calls that can cause a disconnect between the accounting value of shareholders' equity and its value in a real-world sense.

But the basic concept is that shareholders' equity represents an accounting measure of the portion of a company that its stockholders own, net of any debts and other liabilities at a given time.

Market capitalization, or market cap, is a completely different concept. It's what investors judge the company's market value to be at certain point in time.

That market value typically represents not the value of assets vs. liabilities, but investors' judgment of what the company is worth today given the earnings, dividends or cash flow it can generate years and years into the future (or, in some cases, what the company might be worth if were broken up and its various divisions and assets sold separately).

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Usually, though not always, the market value is higher than the shareholders' equity accounting figure.

To arrive at a firm's market value, one simply multiplies the number of shares outstanding times the market price per share.

That worked out to a market cap of $275 billion for Microsoft recently, or almost four times the value of shareholders' equity, although market cap changes each time the stock price moves up or down. (To see Microsoft's market cap right now, click here.

So, when the broad stock market dropped by nearly half from its 2000 high to its 2002 low, it was market cap that declined. Investors essentially made a decision that companies had been valued at too high a price and needed to be knocked down a peg or two or three...

Did companies' shareholders' equity also decline? That depends.

If the company made a profit over the period the market dropped -- as Microsoft did -- then its shareholders' equity likely increased. A company's shareholders' equity could also increase if they sold new stock to the public over the period of the market decline.

If, on the other hand, the company showed a net loss during the period of the decline -- as many high-flying dot-com and small tech stocks did -- then its shareholders' equity dropped.

In an accounting sense, this results because losses on a company's income statement eventually filter back to its balance sheet, reducing shareholders' equity.

Accounting aside, however, what's actually going on is that a company is taking shareholders' equity and converting it into an asset -- say, software or web services -- and then converting that asset for less cash than it had to begin with.

In other words, instead of increasing the pile of money the company collected from shareholders when it originally sold stock to the public, it's whittling down the value of that money by incurring losses. That's what the term "burn rate" that was popular in the '90s referred to -- many tech and dot-com firms were unable to post a profit and thus were just burning through the money their investors put up.

So, shareholders' equity and market cap are two completely different concepts that can move in the same or opposite directions depending on the circumstances.

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Ultimately, though, the two concepts are linked in that a company that posts losses year after year and sees its accounting shareholders' equity decline will probably also see its market cap eventually decline as investors begin to wonder whether or not the company will ever actually turn a profit, or a large enough one to justify its stock price.

So when you're evaluating a company, you want to keep an eye on both. Monitoring the path of shareholders' equity can help you determine whether a company has been making money from its ongoing operations, while tracking market cap can give you an idea of what investors think of the future prospects of the firm.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Mondays.