What is a 'Capital Stock'
Capital stock is the common and preferred stock a company is authorized to issue according to the corporate charter. Accountants define capital stock as one component of the equity section in a company's balance sheet. Firms can issue more capital stock over time or buy back shares that are currently owned by shareholders.
BREAKING DOWN 'Capital Stock'
Capital is defined as the total dollars a company receives to operate the business. Capital can be obtained by issuing stock (equity) or debt securities. Companies with consistent corporate profits raise more firm capital by issuing debt, because the firm can generate income to make interest payments. On the other hand, businesses with less consistent earnings raise funds by issuing equity. Investment firms perform financial statement analysis to determine if a company should issue stock, debt or a combination of both types of securities.
Factoring in the Corporation Charter
A corporate charter is the legal document used to start a corporation. The charter includes the total amount of authorized shares of stock. Authorized stock refers to the maximum amount of shares that the firm can issue during the corporation's existence; those shares can be either common or preferred stock shares. A business can issue shares over time, as long as the total number of shares does not exceed the authorized amount.
The Differences Between Common and Preferred Stock
Preferred stock dividends are typically a stated dollar amount. These dividends are paid before common stock dividends. In some cases, the preferred dividends accumulate and must be paid later, if company earnings are not sufficient to pay the preferred dividend in the current year. In the event of company liquidation, preferred shareholders have a claim on any remaining company assets that takes priority over common stock owners.
How Stock is Presented in the Balance Sheet
The equity section of the balance sheet is composed of three account balances: including common stock, additional paid-in capital and retained earnings. The common stock balance is calculated as the par value of the common stock multiplied by the number of common stock shares outstanding. Par value is a fixed dollar amount assigned to each common share and the amount paid by investors above the par value is posted to additional paid in capital. If, for example, the par value of the stock is $10 per share and shares are issued to the public for $30, the additional paid in capital is increased by $20 per share.
Preferred stock shares are also posted to the equity section of the balance sheet, and the preferred shares have a different dollar amount of par value.