What Is Capital Stock?
Capital stock is the amount of common and preferred shares that a company is authorized to issue, according to its corporate charter. Capital stock can only be issued by the company and is the maximum number of shares that can ever be outstanding. The amount is listed on the balance sheet in the company's shareholders' equity section.
- Capital stock is the amount of common and preferred shares that a company is authorized to issue—recorded on the balance sheet under shareholders' equity.
- The amount of capital stock is the maximum amount of shares that a company can ever have outstanding.
- Issuing capital stock allows a company to raise money without incurring debt.
- The drawbacks of issuing capital stock are that the company relinquishes more control and dilutes the value of outstanding shares.
Understanding Capital Stock
Capital stock can be issued by a company to raise capital to grow its business. Issued shares can be bought by investors—who seek price appreciation and dividends—or exchanged for assets, such as equipment needed for operations.
The number of outstanding shares, which are shares issued to investors, is not necessarily equal to the number of available or authorized shares. Authorized shares are those that a company is legally able to issue—the capital stock, while outstanding shares are those that have actually been issued and remain outstanding to shareholders.
Issuing capital stock can allow a company to raise money without incurring a debt burden and the associated interest charges. The drawbacks are that the company would be relinquishing more of its equity and diluting the value of each outstanding share.
The amount that a company receives from issuing capital stock is considered to be capital contributions from investors and is reported as paid-in capital and additional paid-in capital in the stockholder's equity section of the balance sheet.
The common stock balance is calculated as the nominal or par value of the common stock multiplied by the number of common stock shares outstanding. The nominal value of a company's stock is an arbitrary value assigned for balance sheet purposes when the company is issuing shares—and is generally $1 or less. It has no relation to the market price.
Example of Capital Stock
If a company obtains authorization to raise $5 million and its stock has a par value of $1, it may issue and sell up to 5 million shares of stock. The difference between the par value and the sale price of the stock is logged under shareholders' equity as additional paid-in capital.
If the stock sells for $10, $5 million will be recorded as paid-in capital, while $45 million will be treated as additional paid-in capital.
Consider, Apple (AAPL), which has authorized 12.6 million shares with a $0.00001 par value. The 12.6 million is its capital stock. Meanwhile, as of June 27, 2020, Apple had issued 4,283,939 shares and had 4,443,236 outstanding.
Firms can issue some of the capital stock over time or buy back shares that are currently owned by shareholders. Previously outstanding shares that are bought back by the company are known as Treasury shares.
Authorized stock refers to the maximum number of shares a firm is allowed to issue based on the board of directors' approval. Those shares can be either common or preferred stock shares. A business can issue shares over time, so long as the total number of shares does not exceed the authorized amount. Authorizing a number of shares is an exercise that incurs legal cost, and authorizing a large number of shares that can be issued over time is a way to optimize this cost.
Preferred stock is listed first in the shareholders' equity section of the balance sheet, because its owners receive dividends before the owners of common stock, and have preference during liquidation. Its par value is different from the common stock, and sometimes represents the initial selling price per share, which is used to calculate its dividend payments.
Total par value equals the number of preferred stock shares outstanding times the par value per share. For example, if a company has 1 million shares of preferred stock at $25 par value per share, it reports a par value of $25 million.