April 1, 2013
Owner’s equity is the interest that common and preferred stockholders have in a company. Stockholders have paid-in capital in the form of stock and bonds to a company to provide cash intended to be used for operations of the company. Investors use equity accounts to evaluate the strength and liquidity of a company. Investors assess if a company is growing by comparing capital accounts in previous years to present year by determining if the company is reinvesting funds to keep it operational. Paid in capital is the funding from sale of capital stock. Paid in capital is new money meant to assist the company in increasing their earned capital. Earned capital is money the company earns from profitable operations. The earned capital is the retained earnings, the accumulated income that a company has earned from normal daily and yearly operations. Both forms of equity capital are represented in the equity section of the balance sheet. If the company combines the two it would be misrepresenting the earnings potential from the operations. Retained earnings should be reported separately from contributed capital so companies can measure and track the accumulated net income over time. Investors are more concerned that a company earns the majority of its money from its operations. Earned capital provides for internal financing, budgeting, and absorbing any asset losses. The amount of earned capital a company reports on the financial statements which is in excess of the sale of stock can show the investor that the company is profitable from its own operations and is a good value to invest in. Another way that investors can find the value of a company is by analyzing the earnings per share. There are two types of earnings per share, Basic earnings per share and diluted earnings per share. Some investors use basic earnings per share and diluted earnings per share to calculate how much a stock is worth to them. Basic earnings per share is the profit earned over a certain period of time and divided by the average number of shares of stock the company has issued. Basic earnings per share can be calculated by using the formula basic earnings per share equals net income minus preferred dividends divided by weighted average number of common shares outstanding (Investopedia, 2013). If the company has a simple capital structure is would only have to report just the basic earnings per share on the financial statements. Diluted earnings per share show all potential dilutive common shares that are outstanding during the period. A company that has a large amount of future stock to issue the true earnings per share would be lower than the basic earnings per share. Diluted earnings per share are usually considered to be more precise than the basic earnings per share. Diluted earnings per share are calculated by adding into the formula the stock options, stocks, bonds, warrants, and other securities that would create the dilution. The formula would be net profit divided by the number of shares adjusted for future dilutions, such as outstanding holders of the equity warrants, convertible bonds, convertible preferred shares and stock options, exercise their options to obtain common shares (Equitymaster, 2013). If a company has a complex capital structure it must report both the basic earnings per share and diluted earnings per share on the financial statements. The diluted earnings per share will be less than the basic earnings per share. Investors should prefer to use the diluted earnings per share numbers over the basic earnings per share as it will indicate the possible worst case. The diluted earnings per share will make comparisons between various companies relevant when deciding which company to invest in. Top financial analysts and experts, such as Benjamin Graham a famous value investor use the diluted earnings per share to help make the...