Contributed capital, also called paid-up capital, is the amount of cash and other assets that shareholders have given the company in exchange for shares. In other words, contributed capital is reported in the share capital section of the balance sheet and is generally broken down into two different accounts:
- Common Stock: Common stock is the par value of the shares in issue. The company’s common stock appears as common and preferred stock on the balance sheet below.
- Additional Paid-In Capital: This reserve of the company represents the paid-in money that is paid into the company by the shareholders of the company above the nominal value.
The common stock account represents the total face value of all shares outstanding. In addition to the nominal account, the amount of money above the nominal value that the shareholders were willing to pay for their shares is displayed.
Example of Contributed Capital
The XYC Company has issued shares to its shareholders worth $10,000 in face value. In return, he paid $20 per share, which resulted in $200,000 in equity that the company raised. Thereafter, the company would record $50,000 in common stock and $150,000 in paid-up capital above par.
The total in these two accounts shows the amounts that investors would have to pay to receive shares in the company. The amounts also explain the concept of invested capital, which was equivalent to $200,000.
Components of Contributed Capital Formula
Contributed Capital = Common Stock + Additional Paid-In Capital
In the meantime, there are other components that keep a business going, including:
- Net Income – This is the income a business generates from doing business and is generally, or should be, greater than the costs it incurs. Under normal circumstances, they are accounted for in specific periods. Let’s say a month or a quarter and in the long run it is a year. The net profit is distributed to the shareholders who receive part of the net profit.
- Asset Financing– Every business, regardless of the industry, needs things like inventory, among other things. However, you may need funding to fund some of these things. In addition to financial institutions, investors are other important sources of finance who acquire stakes and capital in the company in this way.
Advantages of Contributed Capital
1# No Burden on Fixed Payment
The amount received in the form of contributed capital does not increase the fixed costs or the fixed payment burden of the company, therefore there are no fixed payment obligations that exist in the event that the principal is in the form of a loan from the company from regular interest payments.
In return, the company pays dividends to the shareholders in the event of a profit. But even in the case of profits, a dividend payment is not absolutely necessary, as this is postponed and diverted to other business opportunities or needs if necessary to improve the business.
2# Zero Collateral
For stocks issued, investors do not require collateral, which may be present if the company borrows funds. In addition, the company’s existing assets remain free, which are then available if they are required as collateral for future loans in addition to the existing assets in the event that the company can use the funds raised by issuing share capital to acquire new assets use the company for the future to secure its long-term liabilities.
3# No Limits on Using Funds
The main motive of the fund provider when the company borrows the fund is to pay debts and interest on time. So, if a lender wants to ensure that the loan proceeds are used in areas where the money for loan repayment can be generated on time, the lender sets financial covenants that restrict the use of the loans. However, this limitation does not apply to equity investors who rely on governance rights to protect their interests.
Disadvantages of Contributed Capital
1# No Guaranteed Return
From the investor’s point of view, the capital brought in does not guarantee them profit, growth or dividends, and its returns are less certain than those of the debtors. Investors expect a higher return on their investment.
2# Dissolution of Ownership
Stock investors have governance rights to elect a board of directors and approve many key business decisions of the company. Ownership and control as well as more control over management decisions.
Ways to Increase Contributed Capital
Every time an investor buys more shares of the company, they are recorded under paid-in capital on the balance sheet. But there are several ways to increase these shares, let’s look at some!
- Preference Shares Issuance: This happens when a company is unable to issue additional common shares, perhaps because the market is not good and therefore the value of the shares is not strong, so the preference share issue is likely to increase.
- New Shares Issuance: Shares are issued to investors during the formation of a company. Investors buy common stocks which are re-journaled and booked at par. However, the company may also decide to seek further funding for a new project, that is, to offer new shares for sale to investors, at which point a new journal will open and adjust to reflect the new holdings on the balance sheet.
- Capital Structure: Differences between equity and debt are likely to affect the state of the capital structure. However, if the optimal structure rises faster than the capital structure, debt financing suffers, which in turn affects common and preferred stocks. In the long term, the entire paid-in capital is also affected.
The Final Words
Contributed capital is the accounting entry in the company’s balance sheet in the form of ordinary shares and capital reserve, which shows the amount that the company has raised by issuing the shares acquired by the company’s shareholders. The shares can be acquired by the shareholders against cash payment or against the company’s fixed assets.
In addition, there is the option of acquiring the company’s shares against debt relief from the company. Each of the aforementioned aspects leads to an increase in equity. Only those capital are recorded that are sold directly to the company’s investors.