What Is Paid-in Capital?

DEFINITION
Paid-in capital, or “contributed capital,” is the amount of shareholder’s equity that has been invested by shareholders and not earned by business operations.

Paid-in capital, or “contributed capital,” is the amount of shareholder’s equity that has been invested by shareholders and not earned by business operations. Paid-in capital is typically broken down into two line items on the balance sheet: common stock and additional paid-in capital.

Definition and Examples of Paid-in Capital

Paid-in capital is the amount of money a company has raised by issuing shares to investors. Paid-in capital is calculated by adding balance-sheet line items common stock, preferred stock, and additional paid-in capital.

Common stock and preferred stock are recorded at par value. Par value is a nominal amount (usually one cent per share) assigned to each share of stock. The rest of contributed capital is assigned to additional paid-in capital, which sometimes is called “capital surplus”. Both of these line items are recorded at their original amounts and not changed as the market value of the stock changes.

Paid-in capital and its counterpart, earned capital, tell the story of how much money has been contributed to a company by investors and by operations.

• Alternate name: Contributed capital

As an example, here is Target’s (TGT) Oct. 31, 2021, balance sheet:

Target’s total paid-in capital of \$6.42 billion is made up of only \$40 million in common stock, at par value, and \$6.38 billion of additional paid-in capital shareholders have invested in the company.

You can also back into the paid-in capital formula by subtracting retained earnings and other comprehensive income from the total shareholder’s equity balance. For Target’s Q3 2021 results, the formula would be:

\$13.80 billion - (\$8.07 billion - \$687 million) = \$6.42 billion

How Paid-in Capital Works

Businesses raise paid-in capital with new issuances of common and preferred stock. They can reduce it through treasury stock, which is when a company buys back its own shares.

Many states require that common stock is first issued at par value when the company is founded, but some states don’t require it. From there, all further issuances of stock are added to the three paid-in capital accounts.

Common Stock

Common stock is the stock that trades on the stock market. Common stock grants the owner voting rights and a right to dividends (if issued). Businesses typically list their common stock on the market through an initial public offering (IPO). Once the stock has been listed, the company may choose to generate more capital through a secondary public offering.

Preferred Stock

Preferred stock is similar to common stock, but also similar to fixed-income instruments such as bonds. Preferred stockholders get their dividends before common stockholders do, and they get payment precedence if the company goes bankrupt. Preferred stock typically has less capital appreciation upside than common stock because it has no voting rights.

Treasury Stock

Treasury stock is all the company’s stock that the company has reacquired. Remember, common and preferred stock are reported at their original amounts and only changed if there are new issuances. Treasury stock is the contra asset account used to account for repurchases.

Companies buy back stock for a variety of reasons, including boosting earnings per share, undervalued stock, and returning value to shareholders.

Paid-in Capital vs. Earned Capital

Paid-in capital tells an analyst how much money has been invested in a business, and earned capital tells the analyst how much money has been generated by the company’s operations and investments.

Earned capital, or “retained earnings,” is the other half of shareholder’s equity. Retained earnings are the sum total of all profit the company has earned minus any dividends distributed to shareholders.

As a general rule of thumb, you want earned capital to be substantially more than paid-in capital by the time a company is a stalwart stock. Otherwise, the sum total of investment made in the company will not have generated a satisfactory return. Of course, if the company has paid out a lot of dividends, this rule should be adjusted to account for that.

Key Takeaways

• Paid-in capital is the sum of all dollars invested into a company.
• It is also referred to as “contributed capital.”
• You can calculate paid-in capital by adding common and preferred stock with additional paid-in capital or capital surplus on the balance sheet.
• Paid-in capital can be reduced by treasury stock when a business buys back shares.