What is paid-in capital?

Definition and Examples of Paid-In Capital

Paid-in capital, or “contributed capital,” is the amount of shareholders’ equity that has been invested by shareholders and is not earned from business operations. Paid-in capital consists of the total dollars invested in the company. Paid-in capital can be calculated by adding common stock and preferred stock to additional paid-in capital or capital surplus on the balance sheet. Paid-in capital can be reduced through treasury stock when the company buys back its own shares.

How Paid-In Capital Works

Companies increase paid-in capital by issuing new common stock and preferred stock. It can be reduced through treasury stock, which occurs when a company buys back its own shares. Many U.S. states require that common stock be issued at par value when a company is formed, but some states do not require this. Thus, all other stock issuances are added to the three paid-in capital accounts.

Common Stock

Common stock is the stock that trades on the stock market. Common stock gives its owner voting rights and the right to receive dividends (if distributed). Companies typically list their common stock in the market through an initial public offering (IPO). Once the stock is listed, the company may choose to generate additional capital through a secondary offering.

Preferred Stock

Preferred stock is similar to common stock but also resembles fixed-income instruments like bonds. Preferred stockholders receive their dividends before common stockholders and have priority in payment if the company goes bankrupt. Preferred stock often has limited potential for capital appreciation due to the lack of voting rights.

Treasury Stock

Treasury stock is any shares that the company has repurchased. Note that common stock and preferred stock are reported at their original amounts and change only if there are new issuances. Treasury stock is a contra asset account used to account for repurchased shares. Companies buy back their own shares for various reasons, including increasing earnings per share, repurchasing undervalued stock, and returning value to shareholders.

Paid-In Capital vs. Earned Capital

Paid-in capital tells the analyst how much money has been invested in the business, while earned capital tells the analyst how much money has been generated from the company’s operations and investments. Earned capital, or “retained earnings,” is the other half of shareholders’ equity. Retained earnings are the total profits that a company has earned minus any dividends distributed to shareholders.

As a rule of thumb, you want earned capital to be significantly larger than paid-in capital by the time the company becomes a strong stock. Otherwise, the total investment in the company may not have yielded a satisfactory return. Of course, if the company has paid out excessive dividends, this rule should be adjusted to take that into account.

Source: https://www.thebalancemoney.com/what-is-paid-in-capital-5220241

“`