What is Capital Stock?

Last Updated: 10 Jan 2025

The term ‘Capital’ is used in various fields including business finance, capital budgeting, investing, and economics. Capital essentially means wealth in the form of money or assets owned by an individual or organization to start a company or invest. It is also a type of stock that you can invest in. To learn more about capital stock, read on.

Capital Stock

Capital Stock refers to the ownership of a company. It is also another term for corporate share ownership of a company. The definition of Capital Stock is the amount of equity and preference shares a company is authorized to issue according to the articles of association. The amount of Capital Stock is mentioned in the Balance Sheet of a company under Owners Equity. Needless to say, capital stock can only be issued by a company.

Capital Stock includes the maximum number of shares that can be outstanding at any time. However, it is not the same as the outstanding number of shares of the company. Capital Stock is also known as the Authorized Share Capital of a company that is legally issued to the public. On the other hand, outstanding shares refer to those shares which have been issued and remain outstanding. Thus, outstanding shares are a subset of authorized share capital.

How are Capital Stocks allocated?

The Board of Directors of a company approves the maximum number of shares that may be issued. The share could either be equity or preference shares. The business may issue shares over time subject to the authorized share capital. Authorizing several shares incurs significant legal costs. Thus, authorizing a large number of shares that may be issued over time proves to be cost-effective.

Capital stocks also include preference shares. However, preference shareholders are paid dividends before equity shareholders. At times, the rate of dividend for preference shares is predetermined. Also, preference shareholders are prioritized over equity shareholders at the time of liquidation. Preferred stock may lose its value if inflation rises since the dividend paid to preference shareholders is fixed. In contrast, the dividend paid to equity shareholders depends upon the company’s financial performance.

Capital Stock and Trading

It is worthwhile to note that share trading or stock trading does not have any impact on the capital stock of the company. Furthermore, each company maintains a register that includes the names of the current shareholders of the company along with their correspondence details. The shareholder’s register is updated with each change in ownership of the company.

How to calculate the value of Capital Stock?

Capital Stock is valued in terms of its face value and market value. Face value or par value is a nominal amount arbitrarily assigned from a financial reporting perspective at the time of issuance of shares. The face value is generally in multiples of Rs. 10. The face value of a stock has no relation to the market price. The market price is referred to the price at which shares are currently traded in the market. Let’s consider an example to understand the valuation of Capital Stock.

Suppose ABCD Limited is authorized to issue 1 Lakh Equity Shares with a face value of Rs. 10 each and 0.50 Lakh Preference Shares with a face value of Rs. 5 each. The number of outstanding equity and preference shares is 0.75 Lakh and 0.10 Lakh respectively. The market value of equity shares and preference shares is Rs. 550 and Rs. 300 respectively.

Therefore, the value of the Capital Stock is Rs. 12.5 Lakhs i.e. Rs. 10 Lakhs of Equity Shares and Rs. 2.5 Lakhs of Preference Shares.

The par value of the outstanding shares is Rs. 8 Lakhs i.e. Rs. 7.5 Lakhs of Equity Shares and Rs. 0.5 Lakhs of Preference Shares.

The market value of the outstanding shares is Rs. 442.5 Lakhs i.e. Rs. 412.5 Lakhs of Equity Shares and Rs. 30 Lakhs of Preference Shares.

Advantages of Capital stock

Here are some benefits of stock issuance:

• Debt reduction: A company can issue stock and raise enough capital to fund operations without debt. It can also use the money to repay its earlier debts and become debt-free.
• Perform acquisition: In equity acquisitions, a corporation can serve its stakeholders with the acquired company’s common stock, which can be liquidated in cash.
• Gain more investors: A corporation can attract more investors by issuing common stock since shares can be bought and sold. Companies can do this by issuing an IPO (initial public offering) and a secondary price offering.
• Raising credit rating: Rating agencies provide credit ratings that reflect a company’s financial strength. If a firm generates capital through issuing stocks, agencies are more likely to award it a higher credit rating.

Final Word

Investing in capital stock is a great investment option only if you have performed the appropriate research and determined that it is the correct financial path for you, facilitated by a stock trading app. If you require any assistance, you can consult the experts at IIFL. Furthermore, you would require a trading account to buy and sell your capital stock which can be done through IIFL’s intuitive online platform in a few simple steps.

Frequently Asked Questions

1. What happens when the company buys back its shares of capital stock?

When a company repurchases some of the outstanding shares, it is referred to as a stock buyback. Buyback of shares is also referred to as treasury stock which is authorized and issued. However, it is not considered while computing the number of outstanding shares. Legally, a listed company is not permitted to own shares of its capital stock. Hence, treasury stock is reduced from the capital stock in the balance sheet of a company. Typically, a company buys back shares of its capital stock in case of excess liquidity. Buyback aids in consolidation of control and management of the company.

2. Can a company repay share capital?

As a general rule, a company cannot repay share capital with a few exceptions, such as an approved reduction of capital, both by the shareholders and the court. This gives the business its solvency and protects creditors from possible harm.

3. What are the disadvantages of the buyback of shares?

Buybacks will likely weaken the company’s cash position, curtail growth avenues, and create an over-levered balance sheet. They might even reflect a lack of lucrative investment opportunities, with damaging implications for long-term shareholder value and market perceptions.

4. Is the return of capital good or bad?

The return of capital is not always bad if the company has a lot of excess cash and no compelling investments. However, it could also indicate limited growth prospects. It may increase the company’s debt burden, thus limiting its financial flexibility, which could have a negative impact on long-term value creation.

5. How to return capital to shareholders?

Capital can be returned to shareholders through various means, such as share buybacks, dividends, or capital reductions. In such deals, shareholders receive cash or additional shares, depending on the company’s and the financial regulations.