Is a Common Stock Considered an Asset?
A balance sheet is an important financial document that investors use to help value a corporation. It has three parts: Assets, Liabilities, and Shareholders' Equity. If a company issues common stock, this increases both shareholders' equity and assets due to the mathematical identity of the balance sheet: Assets = Liabilities + Shareholders' Equity. Common stock is recorded by accountants as shareholders' equity, but the money raised through the sale of the stock is recorded as an asset.
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The Capital Markets
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A public company can raise money from the financial markets by issuing stock. The price of the stock is determined by investors who study the company's financial documents to arrive at a fair price. Accountants prepare these documents, including the balance sheet.
The Balance Sheet
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The balance sheet must balance, meaning that every asset must always equal liabilities plus shareholders' equity. For this reason, accountants make two entries for every financial transaction. When a company issues stock, this is indicated as an increase in shareholders' equity on the balance sheet. The cash received is also indicated as an increase in cash assets. As both assets and shareholders' equity increase by the same amount, the balance sheet "balances".
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Important Ratios
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Depending on how the firm raises money, various ratios important to investors can change. For example, when a company issues stock, earnings per share (EPS) will decrease. EPS is an way investors compare companies in the same industry. If EPS decreases, the stock is less attractive to investors.
Bonds as an Alternative
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A company can also raise money in the form of bonds, and this won't effect EPS. However, bonds increase the long-term debt of the company, changing other ratios important to investors. Also, if a company misses an interest payment on a bond, it can fall into bankruptcy.
Preferred Stock as an Alternative
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The company can also issue preferred stock, which does not effect EPS. However, if either the preferred stock or bonds are convertible to common stock, investors will want to know the "diluted" EPS, which tells them what EPS may be in the future if outstanding convertible preferred stock or bonds are exchanged for common stock.
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