Capital vs. Equity
January 21st, 2010
Copyright © 2009 Integrated Profitability TM
When I started the “Capital” series back in October 2009, I should have taken that critical first step: set definitions.
In the eagerness to get started on something new, and especially on those projects that are really necessary or important, beginnings sometimes get rushed and that can cause rockiness down the way. For example, the series really isn’t about capital, it’s apart a specific portion of capital: the equity, shareholder/owner portion of capital. The series will be re-named “Equity-Capital.”
So, starting at the beginning as we near the end:
Capital Structure:
The percentage of each type of capital used by the firm—debt, preferred stock, and net worth (net worth consists of capital, paid-in capital, and retained earnings).*1
Equity:
The net worth of a business, consisting of capital stock, capital (or paid-in) surplus, earned surplus (or retained earnings), and, occasionally, certain net worth reserves. Common equity is that part of the total net worth belonging to the common stockholders. Total equity would include preferred stockholders. The terms common stock, net worth, and common equity are frequently used interchangeably.*2
Everything perfectly clear now? While doing research for this blog, I came across a passage in a text book under a sub-title of “Definitions of Capital” which I was quite happy to see:
“When accountants refer to capital they mean stockholders’ equity or owners’ equity.”*3
I couldn’t have said it better myself!
Anyway, remember the earlier series on “Numbers People”?
This definitional issue is a perfect example as to why accountants are so critical to the success of a business. They define the transactions, set the standards, and oversee the infrastructure in which the financial booking takes place.
And they keep those finance people in place. Sooner or later.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 50
Telephone: 925-202-6244
Copyright © 2009 Integrated Profitability TM
*1: Eugene F. Brigham, Fundamentals of Financial Management (Illinois: Dryden Press, 1978) p. 568.
*2: Brigham p. 571.
*3: Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting Second Edition (Santa Barbara: Wiley/Hamilton Publication 1977) p. 602.
Equity: Accounting for the Stuff
January 7th, 2010
Copyright © 2010 Integrated Profitability TM
Accountants are indispensable for setting up and maintaining the financial records of your business. They are never more valuable than when accounting for the capital in your business.
Earlier, we covered the two main sources and uses of capital. Here is a high-level overview of how one accounts for the two main sources of capital:
1. Initial Investment
Event:
● Issue 100,000 shares of stock at $1.00 each
● Investors buy the 100,000 shares for an average, net-price of $17.83 per share
● All investors pay for their shares in cash
Balance Sheet
Asset Liabilities
Cash $1,783,000 Liabilities $ 0
Capital
Par Value $ 100,000
Excess over Par $1,683,000
Total: $1,783,000 Total: $1,783,000
2. Retained Earnings
Good news! The first year of business was excellent and your business made money. Being the first year, no dividends were paid and you poured net profit, after tax, back into the business.
Income Statement
Revenue $1,000,000
Expenses $ 875,000
Pre-tax Net Income $ 125,000
Tax $ 43,750
Net-Profit $ 81,250
Since this is a high-level overview, all the in-&-outs of all the activity of the business are not included: for example, cash from the initial stock offering was used to pay the expenses to generate the revenue; as well as buying a few assets necessary to the running of the business.
So, focusing on the capital accounts:
Balance Sheet
Asset Liabilities
Cash $ 112,000 Liabilities $ 0
Capital
Equip $ 552,000 Par Value $ 100,000
Other $1,200,250 Excess over Par $1,683,000
Retained Earnings $ 81,250
Total: $1, 864,250 Total: $1,864,250
That’s the accounting in a nutshell. The migration of “Net Profit” from the Income Statement to the capital account on the Balance Sheet is one of the most intricate accounting processes.
But it is, for owners, the bottom line.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 48
Telephone: 925-202-6244
Copyright © 2009 Integrated Profitability TM
Equity Structures: Market Examples & Other Names for Capital
December 3rd, 2009
Copyright © 2009 Integrated Profitability TM
The Balance Sheet is the financial report that tracks a company’s capital accounts. Picking corporations from different industries, their annual reports show that most of the accounting is standard across industries. Labeling differences are minor:
● Capital in Excess of par value vs. Additional Paid-in capital
● Treasury stock vs. Common Stock in treasury
● Stockholders’ Equity vs. Shareowners’ Equity
The companies selected to illustrate the structure of capital accounts include an automobile manufacturer (Ford), a high-tech computer company (Hewlett-Packard), a grocery chain (Kroger) and a pharmaceutical company (Pfizer).
Capital Accounts for Selected Companies (in millions)
Source: Company Annual Reports
| Ford | HP | Kroger | Pfizer | |
| Preferred Stock | 73 | |||
| Common Stock | 23 | 24 | 955 | 443 |
| Capital in Excess of par value | 9,076 | |||
| Additional Paid-in capital | 14,012 | 3,266 | 70,283 | |
| Accumulated other comprehensive income/(loss) | -(10,085) | -(65) | -(495) | -(4.569) |
| Employee benefit trust | -(425) | |||
| Treasury stock | -(181) | -(57,391) | ||
| Common Stock in treasury | -(6,039) | |||
| Retained earnings (accumulated deficit) | -(16,145) | 24,971 | 7,489 | 49.142 |
| Total Stockholders’ Equity | -(17,311) | 38,942 | 5,176 | 57.556 |
For companies that are structured as corporations, shares of stock, which represent ownership in the company, are issued to the financial markets. As the samples above indicate, stock is issued at par-value (e.g., $1.00) and then sold to investors for prices they are willing to pay. The difference between par-value and what investors actually pay for the stock is “additional paid-in capital.”
After initial capital raising (which might happen in truanches over a period of time), the ongoing operational success of a company’s business drives the amount of capital. The profitability of the company feeds, or starves, the capital accounts. If revenues exceed expenses, then the capital accounts will increase because the amount of “retained earnings” will grow. If revenues do not cover expenses, then the overall capital accounts, the Stockholders’ Equity, will decrease because retained earnings will be lower.
As can be seen from the companies’ capital accounts above, special accounts are set up to handle specific corporate events. The footnotes in the annual reports will provide the nature of such events. Treasury stock are shares, previously issued, that a company buys back when its financial situation and the condition of their stock in the market make it financially worthwhile to remove some of their stock from the investor pool.
Given recent industry history, one can easily see that the capital accounts reflect what is happening in the market place:
● Auto companies are getting hammered
● High tech and pharmaceuticals continue to be in high demand
● Groceries and other staples continue to fulfill ongoing needs
Next in the series: Capital: Its Purpose & Use
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 45
Telephone: 925-202-6244
Copyright © 2009 Integrated Profitability TM
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