What Is Capital Stock?

What Is Capital Stock?

Let me explain capital stock directly: it's the total number of shares a company is authorized to issue, combining both common and preferred shares. This sets the maximum shares that can ever be outstanding, and you'll find this amount on the balance sheet in the shareholders' equity section.

Key Takeaways

You should know that capital stock covers the full amount of common and preferred shares a company can issue. It's recorded under shareholders' equity on the balance sheet. This figure marks the absolute maximum shares outstanding at any time. By issuing it, a company raises funds without taking on debt. However, the downsides include giving up more control and diluting existing shares' value.

Understanding Capital Stock

When a company issues capital stock, it's raising capital to expand its business. Investors buy these issued shares for potential price growth and dividends, or the shares might be traded for assets like equipment. Remember, outstanding shares—those held by investors—don't always match authorized or available shares. Authorized shares are what the company can legally issue, which is the capital stock, while outstanding ones are those actually issued and still with shareholders.

Issuing stock lets a company avoid debt and interest payments. But it means surrendering more equity and reducing each share's value. The proceeds from issuing stock count as capital contributions, shown as paid-in capital and additional paid-in capital in the equity section.

For common stock, the balance is the par value times outstanding shares. Par value is just an arbitrary figure for the balance sheet, usually $1 or less, unrelated to market price.

Example of Capital Stock

Take this scenario: if a company is authorized to raise $5 million with a $1 par value per share, it can issue up to 5 million shares. The gap between par and actual sale price goes under additional paid-in capital. Say the stock sells at $10; then $5 million is paid-in capital, and $45 million is additional paid-in capital.

Look at Apple (AAPL) as a real case—it's authorized 12.6 million shares at $0.00001 par value, making that its capital stock. As of June 27, 2020, it had issued 4,283,939 shares with 4,443,236 outstanding.

Treasury Stock vs. Preferred Stock vs. Common Stock

Companies can issue capital stock gradually or repurchase shares, which become treasury shares—previously outstanding but now held by the company. Authorized stock is the max allowed by the board, covering common or preferred. Issuing over time keeps totals under the authorized limit, and authorizing many shares upfront cuts legal costs.

Preferred stock appears first in equity because its holders get dividends before common stockholders and priority in liquidation. Its par value differs from common, often tied to initial sale price for dividend calculations. Total par for preferred is outstanding shares times par per share—for instance, 1 million shares at $25 par equals $25 million.

Common stock, on the other hand, is the standard ownership share without those preferences.

Formula and Calculation of Capital Stock

Public companies report capital stock value in their quarterly balance sheet's equity section. The formula is straightforward: capital stock equals number of shares issued times par value per share. Keep in mind, different stock classes might have varying par values.

Types of Capital Stock

Beyond basic classes, shares fall into categories by market status. Authorized shares are the maximum from the charter, which might detail how to authorize more. Issued shares are those sold to investors. Unissued are authorized but not yet sold, and together with issued, they total authorized. Treasury shares are bought-back issued shares held by the company, without voting or dividends. Outstanding shares are those still with external investors, post-buybacks.

Valuation of Capital Stock

You value capital stock by its par value plus additional paid-in capital, which is the excess investors pay over par. In an IPO, the price exceeds par, adding to additional paid-in capital. Secondary offerings or buybacks also impact this value.

Advantages and Disadvantages of Capital Stock

Selling equity stock is a primary way to raise capital, but it has trade-offs. It's cheaper than borrowing since there's no repayment schedule or interest, and issuing new shares is low-cost, often at prices far above issuance expenses.

On the downside, it means loss of control—selling majority voting shares risks founders losing direction over the company. Even minority sales trigger securities laws requiring financial transparency. Plus, new issues dilute existing shares' value, forcing the company to boost market cap or buy back to restore it.

How Long Should You Hold Stock for Long-term Capital Gains?

If you hold stock or assets over a year, they're taxed at the lower long-term capital gains rate, except for top earners. Short-term holdings get taxed at your regular income rate.

How Do You Avoid the Capital Gains Tax?

Capital gains tax hits profits from selling investments. Hold over a year to cut the rate—short-term sales face higher ordinary income tax. Use capital losses to offset gains.

What Is Capital Stock in Accounting?

In accounting, it's the value of shares held by outside investors, figured as par value times outstanding shares.

The Bottom Line

Capital stock is essentially the ownership shares in a company's equity, as preferred or common stock. Companies sell them to fund operations, giving investors ownership perks like dividends or votes in return.