Separation of Paid in Capital from Earned Capital Paid-in capital and earned capital are two different types of capital a company generates. Paid-in capital is the amount of funds paid in from stockholders to be used in the business (Weygandt et al., 2013). This capital is generated when the company offers to sell shares of stock. When a company’s operations are profitable, this generates earned capital. Most companies will use the earned capital to reinvest back into the company so it can continue to grow. The left over amount is retained earnings, which can later be distributed as dividends. It is important to keep these values separated, so investors can see how profitable a company is by seeing exactly where the capital is coming from. A company that makes more earned capital is bound to be more profitable. Paid-in capital will eventually be paid back to the stockholder if they decide to sell back their stock shares. If a company runs out of paid-in capital and is not generating enough earned capital, the company will eventually fail. Paid in Capital versus Earned Capital When investing in a company, it is important to compare the paid-in capital with the earned capital. …show more content…
If most of the company’s capital is from paid-in capital, is the company profitable? This is why earned capital is much more important to investors. Paid-in capital is very important to a company when first starting out. The company will use that capital to eventually produce more earned capital. Earned capital is the actual profit the company is making from their operations. A company that makes high-earned capital is more likely to pay out dividends. For an investor dividends are very important because this is how investors make profits. To an investor, paid-in capital will turn to earned capital, which then should result in dividends and higher stock prices. Which is More Important? Basic Earning or Diluted Earning The earnings of a stock are reported in two ways, the basic and diluted earnings per share (EPS) (Weygandt et al., 2013). …show more content…
The basic earnings of a stock is determined by the net income minus preferred dividends divided by the weighted average number of common stock shares outstanding during a reporting period (Weygandt et al., 2013). Some companies that have a more complex capital structure dilute the earnings per share. Shares such as stock options, warrants, convertible preferred stock, and secondary equity offerings can dilute the EPS (Investopedia, 2015). These factors increase the number of outstanding shares, therefore diluting the overall EPS. For an investor, it is more important to focus on the diluted earnings per share as that will give the investor a more accurate picture as to what the share of stock is actually worth. Conclusion Owner’s equity