What is Share Capital?
Share 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 the owner’s equity in the liability side of the balance sheet of the company.
Let’s take a simple example to illustrate this. Let’s say that Roar Inc. had IPO 6 years ago, and by selling equity shares to the general public, Roar Inc. has sourced $1 million in the 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. 6 years ago, the balance sheet will reflect the same only (and not $5 million).
If Roar Inc. would issue new shares of $0.5 million, then the balance sheet of Roar Inc. would be reflecting $1.5 million.
This share capital example teaches us two important aspects –
- First, it has nothing to do with the market value of the company. 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 firm issues 10,000 shares at $10, its capital would be $100,000. Now, if after 5 years, the market price of each share becomes $100, the capital will only be $100,000 until the firm issues any new shares.
Share Capital Formula
Below is the list of formulas that you can use –
Now, this can look like a simple formula, but we need to break down 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 capital.
- 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 amount of 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, then there would be no additional paid-in capital. We would create a “contributed surplus” account and transfer the whole amount to that.
- Let’s say that 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 would be 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 helps the company balances the assets and the liabilities? When a company issues equity/preferred shares, 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 both its assets and liabilities.
Share Capital Video
This has been a guide to what is Share Capital and its definition. Here we discuss the formula to calculate Share Capital along with practical examples of Starbucks. You may learn more from the following recommended accounting articles –