Companies issue shares to shareholders in exchange for becoming part-owners. These shares constitute equity in a company’s financial statements.
Apart from the company’s ownership, the shareholders also get voting rights. Similarly, they also get the right to receive dividends if the company distributes its profits.
For companies, the equity received from shareholders constitutes finance received for operations. This finance becomes a part of a company’s stockholders’ equity on the balance sheet.
However, it may fall into various headings. Usually, companies show their equity finance through the share capital account.
There are several types of share capital that companies may have. However, it is crucial to understand what share capital is first.
What is Share Capital?
Share capital on the balance sheet refers to the amount invested in a company by its shareholders. There are several other names that companies may use for this amount. For example, companies in the US refer to it as capital stock. Share capital represents the portion of a company’s equity derived through the issue of shares to shareholders.
Share capital can also refer to the number and types of shares that constitute a company’s share structure. Some companies choose to represent this amount in the balance sheet.
Others may break it into different types of equity. Usually, it refers to the par value of the total number of outstanding shares a company has distributed.
In accounting, share capital represents the par value of all issued shares. However, it does not denote the actual finance received by companies.
In some cases, companies may allot shares for a premium or a discount. However, the share capital account will only hold the par value of those shares and not the actual receipt. The difference usually ends up on other accounts.
The only asset for newly incorporated companies will include cash received from initial investors. These companies will only have a cash balance in assets, while shareholders’ equity consists of share capital.
This account differs from other types of equity accounts. For example, the share premium account will include any excess balance received for shares issued for a premium.
Overall, share capital is a crucial account of a company’s balance. It represents the par value of the total number of outstanding shares the company has issued.
This account is highly critical in accounting. Similarly, this account only exists for companies limited by shares. For most companies, the share capital account will be necessary to report their equity.
What Are the Types of Share Capital?
For most companies, the balance sheet will include one or two types of share capital accounts. However, it may also have other classifications. There are different types of share capital that companies will report. Some of the prevalent types of share capital include the following.
Authorized, Registered, or Nominal Share Capital
When a company gets incorporated, it must specify the number of shares it wants to issue. This number comes under the company’s memorandum of association. Companies may use different names to report it in the accounts.
Usually, they refer to it as authorized share capital. In some cases, they may also use nominal or registered share capital. It represents the amount of capital a company can raise through share issuance.
Issued Share Capital
While authorized share capital shows how many shares a company can issue, it does not represent the actual numbers in circulation.
Instead, companies use the allotted share capital to report the total number of shares a company has circulated. This account also represents the par value of the company’s total number of shares already issued.
Usually, companies issue shares from time to time. They don’t distribute all their stock in the market simultaneously.
For most companies, the issued capital will differ from the authorized share capital. Similarly, this account cannot exceed the authorized capital at any time due to the limitation.
Overall, issued share capital represents the actual shares in issuance rather than the registered number.
Subscribed Share Capital
Sometimes, companies will allow shareholders to subscribe to receive new shares. These subscribed shares fall under the company’s subscribed share capital account.
Similarly, they are a part of the issued share capital. For most companies, the number of subscribed and issued shares will be the same.
However, they may also differ in some circumstances.
The subscribed share capital cannot exceed a company’s issued share capital. Companies allot shares to each subscriber according to the resolution released by the company directors.
Unissued Share Capital
As mentioned above, companies usually issue shares from time to time. Therefore, their issued and the authorized share capital will differ.
The residual between both amounts will represent the company’s unissued share capital. This unissued capital represents the number of shares available to a company that it can use to raise finance.
Called-up Share Capital
Called-up capital is a part of a company’s subscribed share capital. This capital represents shares that a company can call up or repurchase.
Companies do not call the full amount for each share allotment at once. Therefore, they call up only the amount they need to raise as finance.
These represent the shares issued to shareholders, understanding they will pay for them later.
Called-up capital represents an amount for which companies have already issued shares. However, it does not denote the actual cash received for those shares.
Furthermore, this capital represents shares for which a company is yet to receive funds.
Paid-up Share Capital
Paid-up share capital is a part of a company’s called-up capital. It represents the funds for which its shareholders have paid.
Paid-up share capital comes when companies call for shareholders to pay for them. The paid-up share capital also represents the residual amount after deducting the outstanding calls from the company’s called-up share capital.
Uncalled Share Capital
When companies issue shares to shareholders, they call for them to pay for those shares. However, they may also not do so. Any shares allotted but not called for represent a company’s uncalled share capital.
This capital also refers to the contingent liability on those shareholders of shareholders. It is the residual amount after deducting the called-up capital from the allotted shares.
Reserve Share Capital
Reserve capital represents shares that a company cannot call unless in case of liquidation. Usually, these shares come after a special resolution with more than three-quarters of the majority votes.
Similarly, companies cannot alter their articles of association to reverse this decision. Reserve share capital has a specific purpose, which is to facilitate liquidation.
Reserve capital has various limitations placed on it. Companies cannot offer this capital as security or convert them into ordinary capital.
However, companies can reverse it through a special court order. Overall, reserve share capital is not available unless the company liquidates.
Circulating and Fixed Share Capital
Circulating share capital is a part of a company’s subscribed capital. This capital comes from operational assets, for example, bank reserves, book debts, bills receivable, etc.
These include funds that companies use for their core operations. It also closely relates to fixed capital, a company’s fixed assets.
Share capital, also known as equity or stock capital, is an important component of a company’s financial structure. It refers to the funds raised by issuing shares to investors in exchange for ownership in the company.
What is the Importance of share capital for the company?
The importance of share capital can be understood in several ways:
- Raising Capital: Share capital is a way for companies to raise funds to finance their operations, invest in growth, or pursue other strategic initiatives. By issuing shares, companies can attract new investors and raise large amounts of capital without taking on debt.
- Sharing Risk: When investors buy shares in a company, they take on a portion of the risk associated with the business. This means that the financial burden of the company’s operations is spread among a larger pool of investors, reducing the risk for each shareholder.
- Liquidity: Shares of a publicly traded company can be bought and sold on a stock exchange, providing shareholders with liquidity for their investments. This makes it easier for investors to sell their shares if they need to raise cash or no longer want to hold the investment.
- Owning a Piece of the Company: When an investor buys shares in a company, they own a piece of the company and are entitled to a portion of the profits in the form of dividends. Additionally, they can benefit from capital appreciation if the company’s stock price rises.
- Facilitating Growth: By issuing shares, companies can bring in new investors who can provide the capital needed to support growth and expansion. This can help the company expand into new markets, develop new products, or acquire other companies.
Share capital plays a vital role in a company’s financial structure and is important for raising capital, sharing risk, providing liquidity, and ownership, and facilitating growth.
What are the Limitation of Share Capital for the Company?
Share capital is a valuable source of funding for companies, but it also has its limitations. Some of the major limitations of share capital are:
- Dilution of Ownership: When a company issues new shares to raise capital, existing shareholders see their ownership stake in the company diluted. This can impact the value of their investment and may also lead to a decrease in control over the company’s operations.
- Limited Control: Shareholders do not have direct control over the company’s operations and decision-making. They only have the right to vote on important matters, such as the election of directors or approval of major transactions, at the annual shareholder meeting.
- Market Volatility: The value of a company’s shares can be affected by market conditions and investor sentiment. This can lead to significant fluctuations in the stock price, making it difficult for companies to raise capital or for investors to realize gains on their investments.
- Cost of Compliance: Companies that issue shares must comply with securities regulations and reporting requirements. This can be costly and time-consuming, and can also divert management’s attention from the company’s core operations.
- Lack of Collateral: Unlike debt, shares do not have any collateral backing and do not pay a fixed rate of return. This means that there is no guarantee of a return on investment and that investors must rely on the performance of the company to generate a return.
In conclusion, while share capital is an important source of funding for companies, it also has its limitations. Companies must weigh the benefits and limitations of share capital when considering its use as a means of financing their operations.
Share capital represents the amount that relates to funds raised through a company’s shareholders. Accounting shows the par value of a company’s total number of outstanding shares.
There are several types of share capital that companies may report. These may include authorized, issued, subscribed, unissued, called-up, paid-up capital, etc.