What Are the Two Primary Ways Companies Increase Common Equity?
You can transform a small business in a number of ways, including acquiring another company, expanding or restructuring existing operations or entering new markets. To accomplish any of these objectives, your company might generate sufficient cash and profits from operations to fund the future growth. If not, you can tap external sources by issuing stock to raise the needed capital to accomplish the transformation.
Your company’s common equity represents both the faith investors have in your small business and the success of your company’s operations. The investment that shareholders make in your business is recorded in the common equity section of your company’s balance sheet. Also documented in the balance sheet is your company’s accumulated retained earnings, which increase as the company's net income grows over time. You also record additional paid-in capital, which is a subsection of retained earnings, in the balance sheet as common equity.
You can raise capital for your small business in part by issuing common shares. To do so, your business might collaborate with an investment bank to make an initial public offering. Following the issuance of these shares, as your company’s profits rise from one period to the next, the share value also increases. Later, your company can also make a secondary offering to raise additional capital to finance the company’s growth. Doing so will dilute the ownership position of the original shareholders.
Your company’s earnings, less any shareholders' dividends, will increase both the earnings retained since the inception of your small business as well as common equity. You might use the retained earnings to finance operations, pay shareholder dividends or pay down debt. In all cases, retained earnings will decrease by the dividends paid amount, the amount of the capital improvement or the paid debt. As your company generates income, both retained earnings and common equity will increase. If your company experiences a loss, both retained earnings and common equity decrease.
Additional paid-in capital is one more way your small business can increase common equity. You account for the amount that your investors pay in excess of the issued common stocks' par value -- the stock’s price during the initial public offer -- in the additional paid-in capital sub-account of retained earnings. To calculate the additional paid-in capital, you subtract the stock’s par value from the stock’s issue price and multiply the difference by the number of shares issued.