Capital Stock: Definition, Calculation, Benefits & Limitations
You must have come across the word “capital” in different fields, such as economics, management, accounting, etc. It primarily refers to the wealth owned by an entity/organisation/company in the form of tangible and intangible assets.
Apart from this, there is also capital stock of a company which are shares that depict the corporate ownership of the entity.
Let’s discuss the various aspects of this type of stock, such as its benefits and limitations.
What Is Capital Stock?
The capital stock is the total number of equity and preference shares that an entity can issue as per its Memorandum of Association (MoA) and Articles of Incorporation (AoA). In simpler words, it represents the maximum number of shares that can remain outstanding for a company.
The capital stock is recorded in the balance sheet under the equity section. Companies issue their capital stocks to prospective investors and the general public to raise funds for various business activities. One major advantage of issuing these stocks is that an entity can raise funds without incurring debt.
Now that you know the meaning of capital stock let’s move on to its other aspects.
What Are the Types of Capital Stock?
Here are various types of capital stock that a company can issue:
- Authorised shares
This indicates the maximum amount of shares that a company can issue according to the provisions of its AOA and MOA. A company can increase or decrease the authorised capital by modifying its corporate charter as per applicable bylaws and regulations.
- Issued shares
It represents the total shares that the company has issued to its investors out of the authorised capital. One should remember that issued capital can never be greater than authorised capital.
- Unissued shares
This depicts the balance portion of authorised capital, which has not been issued yet. The entity may opt to issue them later as per business requirements.
- Treasury shares
These are those shares that a company repurchases from existing investors. Basically, these stocks form a part of a company’s share buyback arrangements.
- Outstanding shares
These represent those shares which retail and institutional investors hold. It depicts the part of the shares issued by the company other than the ones bought back.
What Is the Formula for Capital Stock?
The capital stock’s formula is as follows:
Capital stock = Face Value Per Share X Number of Shares Authorised
Here, Face Value Per Share refers to the minimum share value that a company determines while issuing such shares to investors. It is a set limit, and companies won’t be issuing the shares for a value lesser than this.
You can use this formula by putting the values of the variables. This formula will help you calculate the maximum amount of shares that a company will ever have outstanding.
How to Calculate Capital Stock’s Value?
You can compute the capital stock by taking into consideration the face value of the share as well as its market value. Face value, also known as the par value of a share, is a nominal value that companies assign as a part of financial reporting while issuing these shares. The face value of shares usually comes in multiples of ₹10.
On the other hand, the market value of shares represents their trading value on various stock exchanges. The face value and market value have no relation.
Now, let’s see the calculation process to find the value of a company’s capital stock:
Suppose there is a company operating in the consumer electronics manufacturing segment which can issue a maximum of 2 lakh equity shares and 1 lakh preference shares. The face value of equity shares stands at ₹20, and the face value of preference shares stands at ₹10. The number of outstanding equity shares is 1 lakh, and the number of outstanding preference shares is 50,000.
The market value of equity shares is ₹250, and the market value of preference shares is ₹150.
Using the above-mentioned variables in the formula, the value of the capital stock would be ₹50 lakh, i.e., ₹40 lakh of equity shares and ₹10 lakh of preference shares.
The par value of the outstanding shares is ₹25 lakh, i.e., ₹20 lakh of equity shares and ₹5 lakh of preference shares.
The market value of the outstanding shares is ₹3.25 crore, i.e., ₹2.5 crores of equity shares and ₹75 lakh of preference shares.
How Do Companies Allocate Capital Stock?
The total capital stock of every company is mentioned in the corporate charter, which is the Articles of Incorporation and Memorandum of Association. The company’s board finalises its capital stock which is then included in the charter.
The total authorised capital stock includes both the preference and equity shares. Out of these authorised shares, the company issues a particular number of shares from time to time. As there are various complexities involved in issuing shares, each issuing round entails high costs and time.
One popular way of issuing shares is an Initial Public Offering (IPO). It is the first issuing round through which a company sells its shares to institutional and retail investors in the primary share market. After the IPO round, the company goes public in the secondary market and gets listed on several stock exchanges.
What Are the Advantages of Issuing Capital Stock?
Here are some advantages of issuing capital stock:
- It is an alternate method for companies to raise funds for financing their expansion and growth activities. Companies can issue shares to receive funds without incurring any debt.
- An entity can mortgage these shares with a financial institution for receiving loans.
- Issuance of capital stock will not lead to any recurring costs for companies like regular interest payments. Therefore, it does not impact cash flows and liquidity.
- Investors can also gain from purchasing capital stock as they receive regular dividend payments and capital appreciation.
What Are the Limitations of Capital Stock?
Although they have several benefits, these facilities come with certain limitations. One major con of capital stock issuance is that promoters will be diluting their control and introducing outsiders to their business. This may lead to internal tussles, delayed decision making and legal suits.
Capital stock represents the maximum number of legally sanctioned shares that a company may issue. It is not a fixed number, and the board may change it as per business requirements. These shares allow the general public and retail investors to become part owners of the company. Investors should do market research and analyse a company’s fundamentals before going ahead with any investment decision.
Frequently Asked Questions
What is the difference between preference and equity share?
As the name suggests, preference shareholders will be given preference in dividend distribution over their equity counterparts. Even in the case of liquidation, the company will first dispose of the liabilities of preference shareholders.
What is the share premium?
The share premium is the price paid for a stock over and above its face value by the investors while buying the shares of a company. It is entirely dependent on the company’s management along with the opinion of valuation consultants, to fix the share premium.
What are the costs involved in issuing shares?
Companies which are issuing shares incur several costs like clerical fees and underwriting costs that are paid to the merchant or investment bankers who serve as the middlemen. Moreover, they must also pay some fees to their respective capital markets regulator.
What is the difference between equity and capital?
Equity represents the total amount that owners and shareholders will receive at the time of liquidation after paying off creditors. On the other hand, capital refers to the financial assets that companies can use in their functioning.