Last Updated on September 27, 2023 by BFSLTeam BFSLTeam
Whether you are a trader or an investor, you may have come across the financial statements of a company at some point. If you recall the balance sheet, you may remember terms like authorised capital, issued capital and the like. Have you ever been confused by these terms and their meaning? If you answered yes to that question, you can learn all about the capital that a company raises in this article. More specifically, this refers to the capital stock of a company. Read on to know more about capital stock.
Table of Content
What is Capital Stock?
Capital stock refers to the total number of equity shares and preference shares that a company is authorised to issue. It is listed in the balance sheet of every company in the section pertaining to shareholders’ equity. The details of the capital stock or the maximum limit on the number of shares that the company can issue are contained in its Memorandum of Association (MoA).
As the meaning of capital stock indicates, a company cannot issue more shares than what is warranted by its capital stock. This is why the figure is relevant both to the company itself as well as the investors interested in buying its shares.
Also Read: Authorized Share Capital: Definition, and Types
What Does Capital Stock Include?
The capital stock of a company is a broad term that includes the following kinds and categories of share capital:
- Equity Shares or Common Stock
Equity shares represent units of ownership in a company. Also known as common stock, these shares give shareholders the right to vote in the company’s annual meetings. Equity shareholders also receive dividends proportionate to their holdings. However, they do not have priority over preference shareholders with regard to dividend payments and payouts in case of liquidation.
- Preference Shares or Preferred Stock
Preference shares, as the name indicates, come with a preferential right to dividends and liquidation payouts. However, shareholders in this category do not have the right to vote in the company’s meetings. To compensate for this, the dividend rates are typically higher than those applicable on equity shares.
Also Read: What are Authorised Stocks?
Capital Stock Formula and Calculation
Now that you know the meaning of capital stock, here is the formula to calculate the capital stock:
| Capital Stock = Total Number of Shares Issued x Par Value per Share |
For example, say a company issues 1,00,000 equity shares at a par value of Rs. 40 each and 50,000 preference shares at a par value of Rs. 30 each. Then, using the above formula, we can compute the capital stock of the company as follows:
Capital stock = Total number of shares issued x Par value per share
= (1,00,000 x Rs. 40) + (50,000 x Rs. 30)
= Rs. 40,00,000 + Rs. 15,00,000
= Rs. 55,00,000
The Importance of Capital Stock for Companies
The capital stock represents the maximum capital that can be raised by a company. A company to raise capital for various reasons. The reasons usually include the following:
- Investment in Research and Development Activities
Research and Development of a new product can be a costly affair, especially in sectors like biotechnology, pharmaceuticals, and information technology. To gather the required capital to fund the R&D, a company can issue capital stock, or a part of it. By pioneering a product or a service, a company can generate huge profit and can be a gamechanger in its journey.
- Purchasing Capital Equipment
A company can seek capital to upgrade or expand its equipment, which can be a major expenditure. The upgrade and expansion could include new machinery for a manufacturing company, servers for a tech company, more vehicles for a delivery company or medical equipment for a healthcare company. The company can avail the required funds by issuing stocks.
- Business Expansion
If a company wants to enter a new domestic or international market, it often requires a significant amount of capital to build the infrastructure, hire employees and adapt the existing products or services to align with the new market. By issuing shares within the limit specified by the capital stock, companies can fund these expansion plans easily.
- New Product Launches
The development and launch of a new product can be costly for any company. A new product requires investment in Research and Development, manufacturing, marketing and distribution. Companies can raise the necessary funds for its new product by issuing stocks which will enable it to pay for the expenses of building and launching the new product.
- Building New Infrastructure
Infrastructure is crucial for any business. Essential infrastructure includes warehouses for storing goods, retail outlets for selling products and even offices for staff and employees. Setting up the necessary infrastructure often requires a large upfront investment, and companies may choose to issue stocks to raise the necessary capital.
- Business Acquisition
Mergers and acquisitions can be a quick way to grow and access new markets, but they come with a high price tag. To finance such strategic moves, companies might opt to issue stocks. In some cases, stocks of the acquiring company can even be used as a form of payment for the company being acquired.
- Debt Repayment
Companies often take debt to meet the expenses of operations or to expand. A company can issue a portion of its capital stock to raise funds to pay off its outstanding debt. This reduces the expenses incurred on the interest and improves the balance sheet of the company.
The Importance of Capital Stock for Investors
As an investor, understanding the definition of capital stock and knowing this metric for the companies you are interested in can be crucial. It helps you get a better idea of how many shares a company can issue and allows you to adjust your trading or investment expectations accordingly.
There are different reasons why you may consider investing in the capital stock of a company, such as the following:
- Short-Term Growth
If the stock you have purchased is quite volatile, it may record huge price jumps over a short span of time. You can use these price movements to your advantage and earn some quick returns in the process.
- Dividend Income
The dividend is part of the profit, made by the company, which is paid out to its shareholders. If you are a long-term investor with dividend-yielding stocks, you can also benefit from the periodic payouts made by the respective companies.
Conclusion
Capital stock is the total number of equity shares and preference shares that a company can issue. The concept of capital stock is important for an investor. It lets you understand the market and better judge the company in which you want to invest.
To begin trading in the stock market, you need to first open a demat and trading account. For this, it is necessary to choose a trusted brokerage partner and Depository Participant like Bajaj Financial Securities Limited. A trusted brand that is a 100% subsidiary of Bajaj Finance Limited, BFSL offers various services like hassle-free demat and trading account opening, margin trade financing, international investing and more.
