Stockholders’ equity can be found on a corporation’s balance sheet. Total stockholders’ equity represents the company’s remaining value after liabilities are subtracted from assets. Stockholders’ equity is comprised of several components, including contributed capital, retained earnings, dividends and treasury stock. Understanding the components of stockholders’ equity can help you determine if an investment is right for your portfolio.
Common and Preferred Stocks
The issuance of common and preferred stock is categorized as contributed capital, which increases total shareholders’ equity. Issued stock is typically recorded under stockholders’ equity at par value, which is the stock’s face value. Any additional money received beyond par is recorded as paid-in capital excess of par. If a corporation does not record par value, the entire proceeds from issued stock is recorded in the common stock account. Whether or not a company includes par value in its financial statements, the effect is the same to stockholders’ equity.
Additional Paid-In Capital
Paid-in capital excess of par is the additional paid-in capital a corporation receives in excess of the stock’s face value. Additional paid-in capital increases total stockholders’ equity. For example, a corporation records its common stock with a par value of $1. It then issues the stock at the market price of $10. The paid-in capital in excess of par recorded is $9. Some states require a corporation to record par value on its financial statements, while others do not.
Retained earnings are the portion of net income a company retains once dividends are paid to shareholders. Retained earnings increase total stockholders’ equity. A company keeps a portion of its earnings to expand business operations, fund research and development and acquire new investments. Corporations with many years of profitability typically hold a large amount in retained earnings. Although a large amount in the account is viewed as a positive sign, it doesn't necessarily mean the company’s cash account is equally as large.
Cash dividends paid to common and preferred shareholders are debited from a corporation's retained earnings account. This results in a decrease in total stockholders' equity. Profitable, well-established companies issue dividends as a way to share income with shareholders. Some new companies do not issue dividends because it is more important to retain all of their earnings to expand business operations.
Treasury stock represents the corporation’s unretired shares it buys back from the open market. On a balance sheet, treasury stock is the difference between a corporation’s issued and outstanding shares. Treasury stock is a contra-equity account, and decreases total stockholders’ equity. A company can record repurchased shares at par value or market cost.
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