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Owners Equity

Essay by   •  September 21, 2013  •  Essay  •  765 Words (4 Pages)  •  788 Views

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Owners Equity Paper

Before investors invest in a company, they must take various items into consideration. First, both paid in capital and earned capital are looked at. These items tell investors how well the company is doing and if the company is profitable. Next, investors look at earnings, basic and diluted. Once an investor takes the above into consideration, they can then make the decision whether to invest in a company or not.

Before one can explain why it is important to keep paid in capital separate from earned capital, one must know the difference between the two. Earned capital, also known as retained earnings, is the capital companies make from everyday operations. "It consists of all undistributed income that remains invested in the company"(Kieso, D. E., Weygandt, J.J., & Warfied, T. D., 2012). Paid in capital is also known as contributed capital. Paid in capital is "the amount provided by stockholders to the corporation for use in the business" (Kieso, D. E., Weygandt, J.J., & Warfied, T. D., 2012). It is important to keep the two separate so the two are clearly stated for investor and stockholder information. Another reason it is important to keep the two separate is dividends are paid out of retained earnings. The money cannot be mixed up because it could have an effect on the amount of retained earnings, which will in turn, affect the amount of dividends to be paid. If paid in capital and earned capital are not kept separate, the net income could be overstated.

As an investor, earned capital is more important than paid in capital. Paid in capital only shows a company can attract money from owners and/or investors. Investors want to see how much revenue a company can generate before he or she decides to invest. Earned capital will show an investor whether or not a company is profitable. If a company has a retained earnings balance that exceeds the amount of paid in capital, an investor is more likely to invest in that company. A company that has most of it money from investors could be a red flag to investors. This shows a company may be less willing to save their company because a lot of the owner's money is not invested.

As an investor basic earnings per share are more important than diluted earnings. Basic earnings "consist only of common stock or includes no potential common stock that upon conversion or exercise could dilute earnings per common share" (Kieso, D. E., Weygandt, J.J., & Warfied, T. D., 2012). In a sense, basic earnings do not reduce the earnings per share. Basic earnings are part of a simple capital structure. Diluted earnings are part of a complex capital structure and have the potential to be converted to common stock. "Upon conversion or exercise by the holder, the

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