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Meaning of Capital Stock
Capital stock is a component of a balance sheet that represents the sum of common as well as preferred stock that a company can issue as authorized by the corporate charter. In other words, capital stock is the amount of capital constituting ordinary and preference shares.
Capital stock is a sum total of common and preferred stock that a company is permitted to issue. The corporate charter of a company would include information on the number of common (equity shares) and preferred shares it is authorized to issue. Capital stock is a sum of the par value of this authorized common stock (ordinary shares) and preferred stock (preference shares). Reported under the shareholder’s equity section of the balance sheet, it is the amount a corporation receives when shares of its capital stock are issued for subscription. This also represents the ownership of the corporation.
Common Vs Preferred Stock
In order to better understand the concept of capital stock, it is important to have a basic idea of common stock and preferred stock of a company and the difference between the two. Most common type of stock issued by a company, equity shares (common stock) entitles shareholders with different rights as compared to preferred stock. It allows the investor to be a part of the company’s growth and profit. Also, the holders of common stock have the privilege to vote on company matters while holders of preferred stock typically do not. But that doesn’t make preferred stock any less lucrative. Holders of preferred stock have right on fixed dividends and take precedence over common stockholders in case of bankruptcy. Thus, whether to buy common or preferred stock is a decision that needs to be taken very cautiously and keeping in mind the risk appetite of the investor.
Capital Stock Calculation
Capital stock calculation can be broken down into determining common stock balance and preferred stock balance. Common stock balance can be calculated by multiplying the par value of the common stock with the number of common shares outstanding.
In a similar fashion, a preferred stock balance can be calculated by multiplying the par value of the preferred stock with the number of preference shares outstanding. The par value of a stock is the initial price at which the stock is offered to the public.
Finding out the par value of a common stock or per share value, in other words, is easy, as this information is readily available in the stock certificates. It is a fixed amount in dollars allocated to each common share. On the other hand, to determine the par value of preferred stock, one would have to look into the prospectus of the preferred stock.
Capital Stock Example
Take for instance; XYZ Corporation has issued 3,000 shares of common stock and 1,000 shares of 10 percent preferred stock. The par value of a common share is $10 and that of preferred share is $50. The balance of capital stock, in this case, would arrive as follows:-
Value of paid-in capital common stock = 3,000 X $10 = $30,000
Value of paid-in capital preferred stock = 1,000 X $50 = $50,000
Total value of company’s issued capital stock = $30,000 + $50,000 = $80,000
Thus, from the example above, the value of capital stock of XYZ Corporation would be shown as $80,000 in their balance sheet. Had the preferred stock be sold at a premium i.e. above the par value of the stock which is generally the case with companies having a sound reputation and prior experience in the venture. The excess value would be considered as additional paid-in capital and recorded accordingly in the balance sheet.
Capital Stock on Balance Sheet
You would not find value of capital stock in asset or liability section of the balance sheet. Rather, a separate section on equity will contain information on value of capital stock along with additional paid-in capital and retained earnings. Any amount received by the investors over and above the par value of capital stock is recorded as additional paid-in capital and is shown separately. As the name suggests, retained earnings are the earnings of the corporation that are retained (and not given out as dividends to investors) for either reinvestment in its core business or for repayment of debt.
Capital Stock in Economics
In economics, capital stock carries a different meaning. It refers to plant, equipment and other assets that facilitate production. In other words, it refers to the ‘machinery’ that helps in production but does not get exhausted/consumed within the process. Lately, financial capital, human capital and social capital have also been included in the definition of economy’s capital stock to make it more inclusive.
Financial capital refers to the cash in hand and obligations, if any, left after the production process is over. Human capital would essentially include the value of acquired skills and talent. Social capital would mean the value of relationships built during the process. Economists used this term to get a pulse of the output level an economy has the capacity to produce.
Capital stock of a company shows soundness of its financial health. The more it is, the better since that would mean less reliance on outside debt. However, this should not mean that a corporation with more debt on its balance sheet would not be a safe bet to invest in. Different financial experts have different opinions on the right mix of equity and debt, a corporation should strive for.1,2