Owners Equity:

Terminology:

Stock – ownership claims to the assets of our company, stockholders vote and have rights to dividends.

Dividends – Distributions of the assets of a company to its' shareholders

Stock Splits – Stock splits increase the number of shares while decreasing the price per share proportionately.

Treasury Stock – stock acquired by a company in the open market and put in the company treasury.

Sources of Capital

There are three sources of capital for all business entities.

1. Borrowing
2. Issue of equity ownership
3. Internally generated net funds from the sale of our product or service

We have talked about borrowing and now we will explore what types of funds are available from the equity market.

Your book does a quick review of proprietorships, partnerships and then corporations. We will focus our discussion on corporations.

Ownership: Corporations issue various forms of ownership.

Shares of Stocks

Common and Preferred

Preferred Stock: The designation preferred means preferred as to the payment of dividends. Preferred stock is almost like debt financing because it carries a dividend rate that is paid in perpetuity. Usually preferred stock is non-voting and is frequently bought by pensions or investors looking for long term returns. The stock may be convertible (into common stock) and or callable at a specified price if the issuing company wishes to retire the stock.

Common Stock: Common stock is the real ownership of a company since it is usually voting (you vote for directors who controls management), the stock also pays dividends when the Board of Directors so declares them and the stock trades in secondary markets (e.g. stock exchanges). What makes the Corporation such a power entity is the ease at which ownership can change hands.

Treasury Stock: When a corporation reacquires its own stock from external stockholders, the stock is identified as treasury stock. One issue is whether treasury stock is an asset of the company. Looking at the journal entry, you might think so.

Treasury stock               $100,000
              Cash                                $100,000

to reacquire 10,000 shares of stock at $10 per share.

However, unlike buying the stock of another company, a company cannot own itself, therefore treasury stock is a contra equity account.

Earning per Share is one of the most watched and reported measures of financial performance. Accountants calculate EPS using several adjustments to accurately reflect EPS for the year. The basic formula is:

Net Income – preferred stock dividends / the weight avg. number of shares outstanding

Breaking down this formula, we see that in the numerator subtracting preferred dividends from net income measures only the earnings available to common shareholders. Also the denominator measures the weighted average number of shares outstanding, this reduces manipulation of the year end figures by buying back shares in December to inflate the EPS figure.

We are noticing that many factors go into the determination of earnings, therefore generalizing financial performance into one figure is a dramatic simplification of how well a company is doing. We must, however concede that the market pays close attention to this figure and consequences of missing the forecast can be severe.