Essay about Owner's Equity

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Owner’s Equity

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Owner’s Equity

Owner’s equity is the capital employed in a company. Owner’s equity is of great importance to the success of an organization. This paper will detail the important aspect of separating paid-in capital from earned capital. Which is more important to an investor, paid-in capital or earned capital? This paper will continue to look, from the point of view of the investor, and answer if basic or diluted earnings per share provide a stronger investment options. The term owner’s equity can be defined as the interest that is owned by common stockholders of a company. The stockholders are the persons that have paid-in capital to a company that will be used for the day to day operations. Equity may also be raised by revenue made by the company. Paid-in-capital and earned capital are the two key components of owners’ equity. Paid-in-capital is also called contributed capital. When a business needs financing sources they usually issue shares. Investors, due to the belief that they share will increase in value, usually pay more than par value per share. Paid-in-capital is the difference between the cost of the shares at par and the actual price that investors paid for them. When a company makes a profit it distributes a portion of that income, or dividends to the stockholders. Earned capital is the portion of net income that companies choose not to distribute as dividends. Earned capital is added back to the company’s net income. Why is it important that paid-in-capital and earned capital is keep separate? There are two types of stockholders, common and preferred. Both are good options sources of capital, it just varies as to just how much controlling interest is offered and the amount of risk a potential investor wants to be responsible for. This means that the two different types of capital must be separated from each other because of the interest of the investors. Investors want to see this separation appear in the organizations financial statements. Not all investors contribute the same in a company. Some investors have contributed more or less than other investors. Plus, if paid-in-capital is combined with earned capital then net income will be overstated. An overstatement of net income will result in invalid financial statements.

As an investor both paid-in-capital and earned capital are important. Mohr (2013), “Investors and potential investors are often interested in the capitalization of a company. How the company handles both its paid-in and earned capital gives investors an indication of how the company is run. For example, if a company has very little paid-in capital but lots of external debt, it can show that the owners do not have a lot of their own money invested and may be more willing to let the company fail. If all of a company's profits are drained off and distributed to the owners every year, it can show that the company may be
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