What Are the Two Main Sources of Stockholders' Equity?
Original post by Will Gish of Demand Media
Stockholder equity is an integral part of capital structure, which is the financing framework used by publicly trade corporations. Simply put, stockholder equity, also known as shareholder and owner equity, constitutes all of the operating capital contributed by or generated through stockholder investment. Stockholder equity comes from two primary sources: paid-in capital and retained earnings. Although these constitute two different revenue streams, the former gives rise to the latter.
Calculating Stockholders' Equity
Calculating stockholder equity is relatively simple. The basic formula accountants use is stockholder equity equals assets, minus liabilities. Anything of value that a company owns, from physical property to intangibles, such as patents, qualifies as an asset. Liabilities constitute any outstanding debts or financial obligations a company maintains, such as loans or bonds. The value of all assets remaining after the deduction of liabilities equals stockholders' equity.
Paid-in capital, also known as contributed capital, comes from investments made by a company’s owners. The issuing of stock constitutes the primary means of raising paid-in capital. Companies issue shares to preferred owners, common owners and large investors. When a company issues more than one type of stock, it references each separately when creating financial accounts of paid-in capital. For instance, if a company issues $10 million worth of common stock and $8 million worth of preferred stock, it includes a total paid-in capital of $18 million on a balance sheet, with annotations indicating types to stock.
Retained earnings, also known as reinvested earnings, constitute all the profit generated from investment capital that a company reinvests in itself. When a company that issues stock posts a profit, it can either pay out the profit as dividends to shareholders, or reinvest the money back into the company. For instance, assume a company generates a profit of $15 million. If that company pays out $3 million in dividends and keeps $12 million within the company to bolster and grow the business, the $12 million constitutes retained earnings.
In financial bookkeeping, stockholder equity constitutes one item, or entry, explained through various sub-items. The sub-items constitute the items comprising the whole. For instance, assume a company posts stockholder equity of $50 million at the end of a fiscal year. If $30 million of this comes from paid-in capital, and $20 million from retained earnings, sub-items for paid-in capital and retained earnings appear along with the stockholder equity total explaining this. Further sub-items under the paid-in capital heading explain which type of stock the $30 mlilion comes from.
- Accounting Coach; Paid-In Capital and Retained Earnings; Harry Averkamp
- Dummies.com; The Statement of Changes in Owners’ Equity Report; John A. Tracy
- “Accounting”; Carl S. Warren et al; 2009
- “Financial Accounting”; James M. Reeve et al; 2009
- Business Dictionary: Capital Structure
About the Author
Will Gish slipped into itinerancy and writing in 2005. His work can be found on various websites. He is the primary entertainment writer for "College Gentleman" magazine and contributes content to various other music and film websites. Gish has a Bachelor of Arts in art history from University of Massachusetts, Amherst.
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