April 13, 2015
Paid in capital and earned capital are two entirely different informational tools used by executives as well as investors when determining how profitable businesses are. Though both earned and paid in capital raise the value of the company, both must be kept separate to allow proper evaluation of the company's owners' equity. As an investor, both types of capital are necessary though one or the other will give different insights into how the company comes across its money. Earnings per share is also a ratio that is evaluated before investments have been made. Basic or diluted earnings per share are again ...view middle of the document...
Another use for keeping earned capital separate is being able to avoid overpaying dividends and also checking the sustainability of the company (Averkamp, n.d.).
Legal capital must be maintained which accounts for the par value of paid-in capital. Legal capital will also allow additional paid-in capital and retained earnings to account for dividends that are distributed. Additionally, other paid-in capital acts as a buffer when dividends are issued or when paying for operating loss before there is a need to use some or all of the legal capital (Averkamp, n.d.).
As an individual user of financial statements paid in capital as well as earned capital is essential. Paid in capital as explained refers to the money paid to the company for shares. This is crucial for an investor to understand where a portion of money is being generated, but not the most important. It is most important to focus on the earned capital since these retained earnings are added to the company's equity and then increases when the business is profitable. Ultimately an investor must look at the profitability and the ability of the company to finance itself over a period of time. It is best for investors to focus on earned capital overpaid in capital (Davoren, n.d.).
From an investors viewpoint, there are also other important ratios to consider. Basic and diluted earnings per share will give a good indication of what will be made as well as what could be made. Basic earnings per share looks at the retained earnings minus dividends divided by the currently outstanding shares giving the earning per share. The diluted earnings per share will still take the retained earnings minus any...