Generally Accepted Accounting Principles (GAAP) require four basic financial statements: balance sheet, income statement, cash flow statement and statement of shareholder's equity. Both the balance sheet and the statement of shareholder's equity are directly impacted by paid-in capital.
Paid-In capital is an account found on the balance sheet under the shareholder's equity section. Paid-in capital is how much money was invested by equity holders. For companies with stock that has a par value, the paid-in capital is the par value of the stock plus the additional paid in capital. The par value of the usually is a certain small value under five dollars to be legal under state law. Additional paid-in capital is just the amount equity of equity invested by the company in excess of par value. Paid-in capital does not include retained earnings but only the amount that was received by the company in exchange for ownership shares in the company.
The shareholder's equity section on the balance sheet is a summary of all of the transactions with shareholders and how much shareholders have invested in the company. It is calculated by subtracting liabilities from assets. There are a number of accounts that make up the section. The most common ones are paid-in capital, retained earnings, and treasury stock. Retained earnings is all of the net income a company has accumulated since it began operations minus dividends paid out. Net income has a positive effect on retained earnings while a net loss has a negative. Treasury stock is a contra equity account and is how much a company has spent in buying back shares of the company. A contra equity account lowers the value of the balance in the shareholder's equity section.
The balance sheet is where all of the assets, liabilities, and shareholder's equity accounts are listed. The balance sheet is calculated under the formula that assets equal liabilities plus shareholder's equity. An asset is something that helps a company generate revenue while a liability is something that a company has to pay cash for. A balance sheet provides information to an investor about a company's capital structure.
Paid in Capital Use
By itself, paid-in capital has no particular use. It doesn't matter to an investor how much money has been invested in a company in excess of par value. Retained earnings, treasury stock, shareholder's equity and return on capital ratios are all more important. However, paid-in capital is an important account as it constitutes part of a company's capital and shareholder's equity. Return on capital and return on equity all use the shareholder's equity account to calculate how well a company uses its capital to generate returns for capital providers.