Capital Stock

Capital stock is the number of common and preferred shares that a company is authorized to issue, according to its corporate charter. The amount received by the corporation when it issued shares of its capital stock is reported in the shareholders' equity section of the balance sheet. Firms can issue more capital stock over time or buy back shares that are currently owned by shareholders.

Capital stock can only be issued by the company and it is the maximum number of shares that can ever be outstanding. It is a means by which a corporation can raise capital to grow their business. The stock issued can be bought by investors, who seek price appreciation and dividends, or exchanged for assets, like equipment needed for operating their business.

The actual number of outstanding shares, which are shares issued to investors, is not necessarily equal to the number of available or authorized shares issued by the company. A company can change this number by voting to amend its charter which often connotes that they plan to issue stock to raise more capital.

Capital Stock = Number of shares issued x Par Value per share

Issuing capital stock could positively impact a corporation's bottom line in that they can 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 in the stockholder's equity section of the balance sheet.

The shareholders’ equity section of the balance sheet is composed of three account balances: common stock, additional paid-in capital and retained earnings.

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 share capital – and is typically $1 or less. It has no relation to market price.

For example, 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 and the sale price of stock, called the share premium, may be considerable, but it is not technically included in share capital or capped by authorized capital limits. So, if the stock sells for $10, $5 million will be recorded as equity capital, while $45 million will be treated as additional paid in capital.

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.

A corporate charter is the legal document used to start a corporation. The charter includes the total number of authorized shares of stock. Authorized stock refers to the maximum number of shares that a firm can issue during its 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.