What is Common Stock?
Common Stock, also known as equity shareholders capital, is the amount of capital contributed by the owners of the business and forms part of stockholders equity. It is shown in the equity part of the balance sheet and signifies the amount of money contributed by the business owners in the business i.e. skin in the game.
Explanation
The owners also called equity shareholders are issued securities in the form of equity shares based on the number of funds contributed by them at the inception of the business and thereafter as well. Such ownership in equity shareholders capital entitles them the right to appoint a board of directors for the functioning of business, taking critical decisions by providing them with voting rights and also to receive the dividend, if any declared by the business for such a category of shareholders. Along with this such holder of common stock appear at the lowest structure in the pyramid of claims in the unlikely event of liquidation of the business. In other words, Common stockholder’s claims are settled only after the claims of all secured creditors are settled, and even that of preference shareholders are settled. Any amount is left after that is used for settling the claims of such common stockholders.
Characteristics
- These stocks provide ownership Interest in the business. By owning an equity shareholders capital, it signifies proportionate ownership share in the business.
- They are the riskiest instruments when compared with other securities issued by the business such as Preference Shares, Debentures, Bond, etc.
- These Stock Investors require higher return vis-à-vis, other security holders, due to higher risk involved.
- Common Stockholders are not mandatorily entitled to receive dividends. In contrast, other securities issued by the business for raising external funds such as Bonds carry fixed Interest in the form of coupons and preference shareholders also receive fixed dividends ( except in case of Non-Cumulative Preference Shares).
- They carry voting rights that enable the common stockholders to take important decisions related to the growth of the business. Further, they provide risk capital for the business.
Example
Let’s take an example.
Ray Company has 10000 common stock outstanding at the end of the year 2018. The company has 2000 outstanding warrants during the year 2019 which can be converted into Equity Shareholders Capital of each share at $20 each. The Market Price of each stock at the end of 2018 is $30 and at the end of 2019 is $40.
The net income of the company at the end of the year 2018 is $12000, and at the end of the year, 2019 is $9000.
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Solution:
Based on the information above, let’s find out the number of Common Stock at the end of the year 2018 and the year 2019 and impact on Earnings Per Share (EPS).
- EPS at the end of the year 2018 = 12000/20000 = 0.60
- EPS at the end of the year 2019 = 9000/21000 = 0.43
- Net Common Stock Issued = 2000 – 1000 = 1000
Types of Common Stock
From a broader perspective, there is no such different type of common stock, and its ownership implies contribution to risk capital of the business with the highest level of risk compared to other financial instruments issued by the company; however, a slightly different type of Equity Shareholders Capital features evolves from the different voting rights offered by such common stocks. These can be bifurcated into three types:
- With equal voting rights
- With differential Voting rights
- With no voting rights.
Common Stock on Balance Sheet
It is shown under the head Owner’s Equity of the Liability side of the Balance sheet.
Further Common Stock is bifurcated into Authorized, Issued and Outstanding Shares
Advantages
- Provides ownership in the business, allows voting rights which enable owners to make a business decision for growth and development of business.
- Essential for starting a business as owners funds are required for any business to start function and build upscale to borrow from external markets.
Disadvantages
- It provides holders of Equity Shareholders Capital with power to tale business decisions which can sometimes be detrimental to the interest of other secured creditors.
- Common stockholders can decide the quantum of dividends to be paid to them and the amount to be retained by the business which is required for the future growth of the business. It has been observed in many cases where promoters have taken huge borrowings and leveraged business instead of plowback profits (Retained Earnings).
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