Owners Equity

Owners Equity

The owners equity in a corporation is known as stockholders equity or shareholders equity. Stock holders equity can be divided into paid in capital and earned capital. The paid in capital comes from the stockholders through the purchase of the company's stocks. Earned capital arises from profitable operations and referred to as retained earnings. The company uses the capital stock account to record the sales of the company's stocks and retained earnings account is used to record earnings in past periods that have not been distributed to stockholders One important fact is the balance of the retained earnings account is not considered a cash balance, but they are the earnings that have been put back into the company.

Why is it important to keep paid-in capital separate from earned capital?

It is important to keep paid in capital and earned capital separate because they represent to individual sources of financial support within the company. Paid in capital represents new funds anticipated to support the firm in increasing their earned capital. Earned capital represents the company's earnings from operations. If the company were to combine the paid in capital and earned capital it would be considered a misrepresentation of the potential earnings from operations.

As an investor, is paid-in capital or earned capital more important? Why?

Investors and creditors search for companies whose stocks are likely to increase in value and requires the evaluation of many aspects within the company. The paid in capital and earned capital are both important to an investor in which then the investor can evaluate how the company is operated. As an investor point of view it is important that the company is earning money from its operations other than selling stocks. If a company has an abundance of external debts and small amounts of paid in capital then this could be a sign that the company's operations are not profitable.

It is important to know the signs of a good investment, if there is limited initial investment by the owners, and there are large amounts of external debt the owners feelings of a loss in the company may not affect them. The other important aspect is to see how the company's profits are distributed at the end of the year in terms of retained earnings, paid dividends, or if the owners use it for their personal assets. The amount of earned capital that a company reports in their financial statements shows stockholders the importance of their investment. In overview a firm that constantly reports paid in capital in excess of earned capital would not be perceived as a good investment prospect.

As an investor, are basic or diluted earnings per share more important? Why?

According to "Keeping Paid-In Capital Separate From Earned Capital