What is Share Capital?
Share Capital is defined as the amount of money the companies raise from the issue of common shares of the company from public and private sources. It is shown under the owner’s equity on the liability side of the company’s balance sheet.
Let’s take a simple example to illustrate this. Let’s say that Roar Inc. had an IPO 6 years ago, and by selling equity shares to the general public, Roar Inc. has sourced $1 million in capital. Since then, Roar Inc. has become a big name, and its market value has become $5 million. However, since Roar Inc. had raised only $1 million through equity financingEquity FinancingEquity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. The money raised from the market does not have to be repaid, unlike debt financing which has a definite repayment schedule. six years ago, the balance sheet will reflect the same (and not $5 million).
If Roar Inc. would issue new shares of $0.5 million, then the balance sheetThen The Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. would reflect $1.5 million.
This share capital example teaches us two important aspects –
- First, it has nothing to do with the company’s market value. No matter what the market value is at today’s time, the balance sheet of the company will also record what it earned at the time of IPO.
- Second, it only takes into account the issued price. If the firm issues 10,000 shares at $10, its capital would be $100,000. Now, if, after five years, the market price of each share becomes $100, the capital will only be $100,000 until the firm issues any new shares.
Table of contents
- Share capital is the money firms raise by offering common shares to public and private investors. It appears on the liability side of the company’s balance sheet under owner equity.
- The company might issue bonds, borrow money from a bank or another financial institution, or both to raise money. Capital may also be increased by selling stock shares.
- When a company issues preferred or equity shares, it makes money. Another responsibility is to commit investors via the stock capital of the business. A company must credit its share capital while debiting its cash to balance its assets and liabilities.
Share Capital Formula
Below is the list of formulas that you can use –
This can look like a simple formula, but we need to break down the issue price into two main components. – the par value and additional paid-in capital. The next formula takes care of that.
Formula #2 (with Par Value)
The two main components of issue price are par value and additional paid-in capitalAdditional Paid-in CapitalAdditional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market..
- Par value is the amount that a firm can call its legal capitalLegal CapitalLegal capital is defined as a portion of a firm's equity that is not permitted to leave the business. It is an amount that cannot be distributed to shareholders as a dividend or in any other way.. In other words, the par value is the minimum price a shareholder must pay to acquire one share of the company.
- Additional paid-in capital is the amount that is the excess of par value. If we deduct par value from the issue price, we will get additional paid-in capital.
Formula #3 (No Par Value)
If a company issues shares at no par value, there would be no additional paid-in capital. We would create a “contributed surplus” account and transfer the whole amount.
- Let’s say Company B has issued 10,000 at $10 per share with no par value. Here, we would transfer the whole amount i.e. ($10 * 100,000) = $1 million to “contributed surplus” account. And there will be no additional paid-in capital.
- The concept of additional paid-in capital will come only when there is a par value per share.
The total capital would be (by using the formula) –
- Share capital formula = Issue Price per Share * Number of Outstanding Shares
- = $10 * 100,000 = $1 million.
Now, it has two portions – par value amount and additional paid-in capital amount.
Here, the par value per share is $1. Then the total par value amount would be –
- Total Par Value Amount = ($1 * 100,000) = $100,000.
- If the par value per share is $1 per share and if the issue price per share is $10 per share, then the additional paid-in capital per share would be = ($10 – $1) = $9 per share.
- That means the total additional paid-in capital would be – Additional Paid in Capital = ($9 * 100,000) = $900,000.And if we add the total par value amount and the additional paid-in capital, we will get the same amount that we got by multiplying the issue price per share and the number of outstanding shares.
Let us have a look at the Shareholders’ Equity section of Starbucks.
source: Starbucks SEC Filings
- Starbucks (2017) = Common Stock (2017) + Additional paid-in capital (2017)
- Starbucks (2017) = 1.4 + 41.1 = $42.5 million
- Starbucks (2016) = Common Stock (2016) + Additional paid-in capital (2016)
- Starbucks (2016) = 1.5 + 41.1 = $42.6 million
Share capital and Balance Sheet
When a company needs more money, it can raise the required capital in multiple ways. It can issue bonds, or it can take debt from a bank or a financial institution. It can also take the help of equity shares and raise capital.
But how does it help the company balance the assets and the liabilities? When a company issues equity/preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation., it receives cash. Cash is an asset. And as the company is liable to the shareholders, share capital would be a liability. So by debiting the cash (or recording the cash as an asset) and crediting the share capital (or recording it as a liability), a company can balance its assets and liabilities.
Share Capital Video
Frequently Asked Questions (FAQs)
Extra shares are distributed to investors as a bonus share issuance. Bonus shares raise a company’s share capital, but its market capitalization is unaffected. A company’s earnings or share reserves are used for a bonus share issue.
If all liabilities exceed all assets, the company will have a negative shareholders’ equity. A low shareholder equity balance is a red flag that prospective stock buyers should learn more about the company.
Unless there is a good cause for the corporation to prohibit it, shares of a public company may be freely transferred. A private limited company’s shares cannot be moved under specific circumstances.
Yes, companies can change their share capital structure by seeking approval from shareholders and complying with legal and regulatory requirements. Changes involve issuing new shares, consolidating shares, or altering the nominal value of shares.
This has been a guide to what Share Capital is and its definition. Here we discuss the formula to calculate Share Capital and practical examples of Starbucks. You may learn more from the following recommended accounting articles –