Paid-in capital and retained earnings are two subsections of a corporation's balance sheet that represent the obligations the company has to its owners. They are subsections of the shareholders' equity section found after liabilities. A company's total assets equal its liabilities to outside entities and its obligations to its equity investors.
The shareholders' equity section of a corporation's balance sheet includes two main components: paid-in capital and retained earnings. Together, they make up the amount of funds that shareholders have invested in the company, either through purchasing shares or by leaving net earnings in the company without withdrawing them. The shareholders' equity section can also contain loans from shareholders to the corporation. Often, short-term loans are reported in the liabilities section, but semi-permanent financing is treated as equity.
Paid-in capital is also called contributed capital. It represents the amount that shareholders have paid directly to the company for shares. It doesn't include anything that shareholders have paid on the open market for shares, only the initial issuance. In the paid-up capital section, the amounts paid for each class of stock are broken out. The two main categories of stock are common (representing ownership in the company) and preferred (most often non-voting investments). Some companies further break down each category into how much was paid based on the par, or face, value of the stock and how much was paid above par. For example, if the company issued common stock that had a face value of $1 per share for the market value of $9, the former would go into the common stock category, and the latter would go into a separate balance sheet account.
Retained earnings is the total accumulation of the company's net income for all of the years it has been in operation minus any amounts paid out to shareholders as dividends. It is the amount of net income that shareholders still have invested in the company and have not taken as a return on their investment. The retained earnings account includes the current year-to-date net income shown on the related income statement. To the company, retained earnings is one method of financing operations. Successful companies that have been in operation for a long period of time often have large retained earnings balances in relation to the amount of debt owed to external lenders. The benefit of this type of internal financing is that the company's board of directors decides if and when it should be distributed to shareholders as dividends.
If a company builds up net losses over the years rather than net income, the negative retained earnings is called an accumulated deficit. This would indicate that a company is not yet profitable. It means that it not only does not have enough money to finance its own operations, it does not have the funds to pay dividends to its shareholders. This is common in the start-up years in a business but can indicate financial trouble in a more well-established company.
Video of the Day
- Hemera Technologies/Photos.com/Getty Images