MGMT 200 Chapter 10: Stockholders' Equity

Primary components of stockholders’ equity

paid-in capital, retained earnings, treasury stock

Paid-in capital (invested capital)

amount of money paid into a company by its owners

Types of business entities

sole proprietorship, partnership, corporation 

Sole proprietorship

business owned by one person

Partnership

business owned by two or more persons

Corporation

an entity that is legally separate from its owners and even pays its own income taxes

Organization chart

stockholders → board of directors → CEO → executive vice president (digital and engineering), COO, CFO, legal counsel, executive vice president (sales and marketing)

Stockholders

ultimately, a corporation’s stockholders control the company

Board of directors

by voting their shares, stockholders determine the makeup of the board of directors

Chief Executive Officer

the board appoints the management to run the company

Stages of equity financing

corporations first raise money from founders of the business, friends, and family; to grow the company, companies seek investments from angel investors, venture capital firms, initial public offering

Angel investors

wealthy investors, think Shark Tank

Venture capital firms

provide additional funding and business expertise

Initial public offering (IPO)

the first time a corporation issues stock to the general public

Publicly held corporation

allows public investment, more stockholders, regulated by the SEC

Privately held corporation

no public investment, fewer stockholders, not regulated by the SEC

Stockholder rights

right to vote, right to receive dividends, right to share in the distribution of assets

Right to vote

stockholders vote on matters, including the election of corporate directors

Right to receive dividends

stockholders share in profits when the company declares dividends, the percentage of shares a stockholder owns determines their share of the dividends distributed

Right to share in the distribution of assets

stockholders share in the distribution of assets if the company is dissolved, the percentage of shares a stockholder owns determines their share of the assets, which are distributed after creditors and preferred stockholders are paid

Advantages of a corporation

limited liability, ability to raise capital and transfer ownership

Disadvantages of a corporation

additional taxes, more paperwork

Types of common stock

authorized, issued, outstanding, treasury

Authorized common stock

shares available to sell (= issued + unissued)

Issued common stock

shares actually sold (= outstanding + treasury)

Outstanding common stock

shares issued and held by investors

Treasury common stock

shares issued and repurchased by the company

Par value

legal capital per share of stock that’s assigned when the corporation is first established, has no relationship to the market value of the common stock

If no par value stock is issued, the corporation records

the full amount to Cash and credits Common Stock

If par value or stated value stock is issued, the corporation records

two equity accounts—Common Stock at the par value or stated value per share and Additional Paid-in Capital for the portion above par or stated value

Preferred stock

“preferred” over common stock because preferred stockholders have first rights to a specified amount of dividends and receive preference over common stockholders in the distribution of assets if corporation is dissolved 

Features of preferred stock

convertible, redeemable, cumulative 

Convertible

shares can be exchanged for common stock

Redeemable

shares can be returned to the corporation at a fixed price

Cumulative

shares receive priority for future dividends if dividends are not paid in a given year

Treasury stock

the purchase of a company’s own issued stock, decreases stockholders’ equity, record treasury stock as a contra account

Companies buy back their own stock to

boost underpriced stock, distribute surplus cash without paying dividends, boost earnings per share, satisfy employee stock ownership plans

Retained earnings

earnings retained in the corporation and not paid out as dividends, normal credit balance, equals all net income less all dividends since the company began operations

Cash dividends

distributions by a corporation to its stockholders, a change in a quarterly or annual cash dividend paid by a company can provide useful information about future prospects, not all companies pay dividends

Declaration date

date on which board of directors announces the next dividend to be paid, decreases Retained Earnings and increases Dividends payable

Record date

the date on which company looks at its records to determine who the stockholders of the company are

Payment date

the date of the actual distribution of dividends, decreases Dividends Payable and decreases Cash

Stock dividends and stock splits

additional shares of stock distributed by corporations to stockholders rather than cash, large stock dividends (25% or more of the shares outstanding) and stock splits are declared primarily due to the effect they have on stock prices

Stock splits

a large stock dividend that includes a reduction in the par or stated value per share, do not record a transaction when declared

Large stock dividends

records a decrease in retained earnings and an increase in common stock; recorded at par value

Effects of a stock split

decreases par value per share, does not change total stockholders’ equity, common stock, or retained earnings

Effects of a stock dividend

increases common stock, decreases retained earnings, does not change total stockholders’ equity or par value per share

Small stock dividends

recorded at market value instead of par value, doesn’t change total assets or liabilities or stockholders’ equity, decreases Retained Earnings and increases Common Stock and Additional Paid-in Capital

Return on equity

measures the ability of company management to generate earnings from the resources that owners provide

Return on equity equation

Return on Equity = Net Income/Average Stockholders’ Equity

Dividend yield

measures how much a company pays out in dividends relative to its share price

Dividend yield equation

Dividend Yield = Dividends Per Share/Stock Price

Earnings per share

measures net income earned per share of common stock

Earnings per share equation

Earnings Per Share = (Net Income - Dividends On Preferred Stock)/Average Shares Of Common Stock Outstanding

Price-earnings ratio

indicated how the stock is trading relative to current earnings

Price-earnings ratio equation

Price-Earnings Ratio = Stock Price/Earnings Per Share