EQUITY FINANCING 1 Debt Financing Loans repay with interest a Liable for amount of loan b Ends with repayment 2 Equity Financing a No responsibility to repay b c Investor takes risk Investor rewarded by company s future success 3 TWO CATEGORIES OF EQUITY a Contributed Capital The amount that owners have contributed through the purchase of stock Common Stock i Preferred Stock Has Dividend Preference If a dividend is paid the preferred stockholders must be paid in full before common stockholders get their dividend NO REQUIREMENT 1 Dividend set as a fixed percentage ii Common Stock Stockholders have voting rights 1 Election of board directors 2 Vote on significant activities of management 3 Dividend rates are determined based on the board of directors and their assessment on profitability 4 RECEIVE DIVIDENDS AFTER PREFERRED STOCKHOLDERS iii Accounting for both types of capital stock is the exact same b Retained Earning The amount of net income the company has earned that has not been paid out as dividends 4 PAR VALUE A monetary amount assigned to each class of stock for accounting purposes only a No relationship to market value b When stock is sold to owners Stockholders the stock account is only recorded at par value i The excess of the selling price of the stock over the par value is recorded in the equity account PAID IN CAPITAL 5 Transactions that involve our own stock NEVER effect the income statement Net Income INCOME STATEMENT 6 a Transactions with our own stock are not effected b NONE 7 BALANCE SHEET a Increase Assets By amount of cash received and Increase Equity both common stock and paid in capital b Assets decrease By amount of cash we had to pay to get shares back and a decrease in equity since the account treasury stock is a contra equity account 8 CASH FLOW a Proceeds from insurance are a financing cash inflow b Cash paid to reacquire stock is financing cash outflow 9 EACH CLASS OF STOCK HAS 3 TYPES OF SHARES a Authorized Shares Total number of shares the company is allowed to sell to the public Issue Shares The total number of shares sold to the public b c Outstanding Shares The total number of shares actually in the hands of our stockholders d The DIFFERENCE between Issued Shares and Outstanding Shares represents the shares of stock issued by the company but then reacquired by them Called TREASURY STOCK i Why would a company buy back its stock 1 REDUCE SHARES OF OUTSTANDING AND INCREASING MARKET VALUE PER SHARE 2 Market price is low 3 Remove shares from the market to avoid hostile takeover Own 51 4 Use in employee stock option programs 5 Give cash back to existing shareholders Increase reported earnings per share 6 10 Treasury Stock Shares we have bought back a Decrease in stockholders equity i Classified as a CONTRA equity account ii Normal balance for the treasury stock account is a debit b Recorded at the buy back cost not at par value c No gains or losses are EVER recorded 11 Re Issuing previously Reacquired Share a When Re issue price Than reacquisition i Excess recorded in the equity account Paid in capital Treasury b When Re issue Price Reaquisition i Reduce paid in capital treasury buy DEBITING the account for the difference 1 Can not be debited more than its balance 2 If deficit still remains after debiting it reduce the Reatined earnings by what is left c WHEN treasury stock is re issued always remove the treasury stock from the balance sheet at its reacquisition cost i Not a gain because it s our stock and it doesn t effect our 12 Divedends income statement a Contra equity account because they reduce equity specifically RE b Once a dividend is declared a liability is created c Paid to Preferred stockholders is a fixed percentage i Preferred Stock Dividend Par value share x 1 Per share dividend ii Total Preferred Stock Dividend Par Value Per Share x x Number of outstanding shares d 3 IMPORTAND DATES FOR DIVIDENDS i Date of Declaration Date BoD decides to pay a dividend 1 Retained earnings is reduced 2 Liability is established 3 Liability Increase and Equity decrease ii Date of Record Date stockholders must own the stock to get the dividend 1 No impact on account records or financial statements iii Date of Payment Date which a corporation pays dividends 1 Financing cash outflow 2 Assets decrease and liabilities decrease e CALCULATIONS i Preferred Stock Dividend 100 x 8 x 5000 Shares 40K ii Common Stock Dividend 198 000 Shares x 2 50 495 000 iii Total Dividend 40 000 495 000 535 000 iv Dividends are only paid on outstanding shares so NO dividends are paid on TREASURY STOCK f Cumulative Preferred Stock Preferred stockholders must be paid both current and prior year dividends before common sotckholders get any g Dividends in Arrears Prior year unpaid preferred stock dividends i Not actual liabilities 13 Financial Statement Ratios Relation to Stockholders Equity a Return on Equity ROE Amount of profit earned per dollar of invested capital each share of stock b Earnings per Share EPS Amount of net income associated with c Price Earnings Ratio P E Ratio Investors expectations regarding the growth of potential and earnings stability of a company