Investment in shares of any company has attracted investors for many decades. For a sound investment in shares, the investors have to look out for many pointers that can point towards the stock being a favourable investment. One such crucial factor is the ability to read the financial statements of the company. Financial statements include a balance sheet, profit and loss statements, cash flow statements, etc. The very first term investors come across in the balance sheet of any company is the share capital.
Equity share capital or share capital is the cumulative value of the total equity shares issued by the company. The total ordinary shares issued by the company are recorded at the face value of such shares in the balance sheet of the company under the head Share capital’ or Equity share capital’. It directly represents the money poured in as capital by the owners and the investors in the company against the shares of the company.
As mentioned above, equity share capital is calculated at the face value of the equity shares issued by the company. The face value of the shares is the par value or the original cost per share of the company. When a company issues shares, such shares can be issued at a discounted price (less than face value), at a premium (higher than face value), or at par (equal to face value).
However, in the books of the company, the equity share capital is recorded at the face value of the shares irrespective of their issue price. Let us take the following example to understand the calculation of equity share capital.
Company A has issued 1,00,000 shares of face value Rs. 10 per share at the issue price of Rs. 12 per share. The equity share capital of company A will be calculated as below.
Equity Share Capital = Rs. 10 * 1,00,000 shares
Equity Share Capital = Rs. 10,00,000
Similarly, if Company B has issued 1,00,000 shares of face value Rs. 10 at an issue price of Rs. 7 per share, the equity share capital will be calculated as under.
Equity Share Capital = Rs. 10 * Rs. 1,00,000 shares
Equity Share Capital = Rs. 10,00,000
There are several types of equity share capital that are part of the balance sheet. Some of the basic types of equity share capital are mentioned below.
Authorized share capital
Authorized shares are the maximum number of shares that can be issued by a company. A company can increase its maximum number of authorized shares by altering its Articles of Association and complying with the required regulations in this regard.
Issued share capital
Issued share capital represents the number of shares agreed by the company ti be issued and offered for subscription.
Subscribed share capital
Subscribed share capital represents the number of issued shares that have been actually subscribed by the investors.
Paid-up share capital
Paid-up capital is the amount for the subscribed shares that have been paid by the investors. In most cases, the investors have to pay the full value of the shares. However, in some cases, investors pay for the shares in gradual payments which deems the shares to be partly paid shares till the full value of shares is not received by the company.
Rights shares
Rights issues are the shares issued by the company to the existing shareholders of the company. A company usually issues rights shares to safeguard or preserve the ownership of the existing shareholders.
Bonus shares
Bonus shares are the shares issued to the existing shareholders out of the company profits as a reward or in the form of dividends.
Equity share capital forms the basis of the initial investment in the company against which the basic assets of the company are built. Some of the main advantages of equity share capital are mentioned hereunder.
- Equity share capital is perpetual in nature. There is no definite timeline to pay back the owners of the company unless in the event of liquidation of the company.
- Contributions to the equity share capital provide even small investors to be owners of the company even though it is in a small capacity.
- Equity shareholders get the benefit of voting rights along with ownership and can contribute to the decision-making process of the company.
- Equity share capital provides the equity shareholders with the ultimate right on the profits made by the company. These profits are distributed to the shareholders in the form of dividends.
After learning about some basic advantages of equity share capital let us now look at a few disadvantages of equity share capital.
- The cost of equity share capital is higher than the cost of debt capital.
- When the company issues more shares, it can dilute the voting rights of the existing shareholders.
- The management of the company may have to face hindrances in the day-to-day working of the organization if the shareholders exert their ownership too much and interfere in the daily workings and the decision-making process of the company.
Preference shares are another type of shares issued by an organization. These shares are different from equity share capital in many ways. Some of the common differences between the two are highlighted hereunder.
| Category | Equity share capital | Preferred Share capital |
| Meaning | Equity share capital is formed out of equity shares issued by the company. | Preference shares are part of the share capital but have preferred rights over ordinary or equity shares. |
| Dividend | The rate of dividend and the frequency of paying equity dividend is not fixed for equity shareholders. | The rate of dividend is fixed for preference shares and has to be paid annually. |
| Voting Rights | Equity shares provide the shareholders with voting rights and decision making authority in annual general meetings or any other meeting called by the company | Preference shareholders do not get any voting rights or decision-making authority in company-related matters. |
| Liquidation rights | Equity share capital provides the residual rights to the shareholders at the time of liquidation. | Preference shareholders have a preferential right to their money over equity shareholders at the time of liquidation. |
| Bonus shares | Equity shareholders are eligible for bonus shares | Preference shareholders are not eligible for bonus shares |
| Arrears in dividends | A dividend on equity share capital is not a mandatory payment but is at the discretion of the company. Hence, they do not have any claim on any arrears if the dividend is not paid for any year. | Preference dividend is a mandatory payment every year and hence they can make a claim for the arrears of dividends not paid for any particular year. |
| Mode of financing | Equity share capital is perpetual in nature and hence is used as long term financing mode. | Preference share capital can be used as a medium-term to a long-term mode of investment. |
Conclusion
Equity share capital is the starting point for any company to begin their operations and ensure stability for their business. However, a company has to beware of the dangers of overcapitalization and undercapitalization which can endanger the existence of any business. It is therefore important to ensure optimum equity share capital which can meet the initial needs of the business and help it grow.
FAQs
Yes. Companies can make fresh issues of equity shares of the same class or different classes to increase the equity share capital. Alternatively, companies can also issue rights shares, bonus shares which can increase the equity share capital.
The returns on equity share capital are the share in profits in the form of dividends or increased EPS or capital gains upon sale of shares.
Dividend on equity share capital is declared at the discretion of the management of the company from the available profits. The company is not obligated to declare dividends every year nor provide a fixed percentage of dividends to equity shareholders.
Yes. The equity share capital has a higher risk or exposure as compared to debt fund or preference share capital.
Yes. Equity shares can be easily transferred from one person to another without any hassles or can be passed on as part of an inheritance.
