Ordinary Shares Capital

Ordinary Shares Capital is defined as the amount of money which is raised by the companies from the issue of the common shares of the company from the public and the private sources and it is shown under owner’s equity in the liability side of the balance sheet of the company.

Ordinary Share Capital Definition

Ordinary share capital is the sum of money raised by a corporate from private and public sources through the issue of its common shares. It is the capital that is received by the owners of the company in exchange for shares. The ordinary share capital has equity ownership in the company in proportion to their holdings. Ordinary Shares Capital is one of the primary ways to finance various projects and purposes. It is usually considered better than debt methods like loans etc.

Ordinary Shares Capital Formula

The formula for ordinary shares capital as per below:

Ordinary Share Capital = Issue Price of Share * Number of Outstanding Shares

Ordinary-Share-Capital

where,

  • The issue price of the share is the face value of the share at which it is available to the public.
  • The number of outstanding shares is the number of shares available to raise the required amount of capital.

Examples of Ordinary Shares Capital

Let’s see some examples of ordinary shares capital to understand it better.

Example #1

Suppose ABC is a US-based company. If the company sells 1000 shares, having a face value of $ 1 per share.

Solution:

Calculation of ordinary shares capital can be done as follows –

Example 1

Issued share capital= $(1000*1)

Issued Share Capital = $1000 of ABC

Example #2

Suppose XYZ is a US-based company with an authorized capital of 1 million shares at a par value of $1 each, for a total of $1 million. However, the issued capital of the company is only 100,000 shares, leaving 900,000 in the company’s treasury available for future issuance.

Solution:

Calculation of ordinary shares capital can be done as follows –

Example 2

Issued share capital= $(100,000*1)

Issued Share Capital = $100,000 of XYZ

Example #3

Let’s assume PQR is a UK based company. Its shareholder owns 50 shares at £1 each. Then these shareholders have to pay the company £50.

Solution:

Calculation of ordinary shares capital can be done as follows –

Example 3

Issued share capital = (50*1)

Issued Share Capital = 50 of PQR.

Advantages of Ordinary Shares Capital

  • In the case of ordinary share capital, the company does not have to bother to repay for the initial investment or interest payments, unlike debt financing.
  • Raising capital through share is very flexible as the company decides the number of shares to issue, initial charge for them, if any, and time to issue them. It can be issued further also in the future as per the requirement of money. If desired, the company can buyback issued shares.
  • Someone has to be the owner of the company. Shareholders take ownership of the company.
  • There is less risk that the company will turn bankrupt. Unlike creditors, Shareholders cannot force a company into bankruptcy if it fails to make payments.
  • They are entitled to receive dividends after it is paid to preference shareholders. During winding up of business, they are entitled to their share of the company’s residual economic value but after bondholders and preferred shareholders.
  • The ordinary shareholders are benefited the most in case startups are sold to big companies. Hence the share capital is impacted positively.

Disadvantages of Ordinary Shares Capital

  • The major obligation that an ordinary shareholder faces is the price of the share he has to pay to the company.
  • The share price fluctuates a lot, which short-term oriented investors find disappointing.
  • Some companies are not so worthy of being part of as shareholders, but due to dishonest auditor may not show it properly. The share capital has to keep a check on shares analysis.
  • A company can raise capital through the issue of shares. Still, then it reduces control and ownership over the company because every share depicts ownership in the company, and hence it passes to the shareholder.
  • If ordinary shareholders have a major proportion in the company, they can even remove the current leaders to bring new management. They can disapprove of the way of doing things.
  • In case of a takeover, the competitor can acquire major voting shares, and thus it can turn to a hostile takeover.
  • In the case of raising capital by shares, a company can lose more shares at a low price to compensate for the risk of raising capital.
  • While issuing further shares, it impacts share value that has already been sold. Share price drops, and hence the dividend per share also drop. It can upset current shareholders. In a worse situation, they can even use their voting power against management.

Limitations of Ordinary Shares Capital

  • An additional cost is always incurred while raising capital for the company through the issue of shares. In comparison to this, in debt financing, interest paid is usually deducted from its taxes.
  • Arrangement of organizing a public share offering includes so much cost implication. The company has to prepare an IPO prospectus for the public invitation so that they can buy shares.
  • Shareholders will have to be updated by the company about its performance and other relevant matters from time to time. Hence, raising capital through the issue of shares includes a time implication.
  • In the initial phases, the main focus of the business may deviate from the main business. Many documents and formalities are required, like the prospectus and other related documents. Not only this, an essential task like organizing advertisements for the sale of shares, and arranging for the implementation of the shares being issued are also to be done.

Important Points

  • As it is a major source of financing incorporation, Ordinary shares must be part of the stock of all companies.
  • Ordinary shareholders are generally considered unsecured creditors. They face greater economic risk than creditors and preferred shareholders of a company.
  • Ordinary shares rank after preference shares for dividends and returns of capital but carry voting rights.

Conclusion

We can conclude that there are many possible ways to raise capital. Out of this, the company can raise capital by issue of shares to the public. It can be more suitable and appropriate as compared to other methods. But, sometimes, it raises further issues for the company. So, proper care must be taken as Ordinary Share capital is the capital generated from ordinary shares issued to the public at large, and the company’s reputation is at stake.

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