If you are new to investing in the stock market, there is quite a bit for you to learn, even in terms of basics. The whole stock exchange and its activities revolve around the concept of stock or shares issued by companies. Hence, it is important for you to understand the economic considerations behind issuance of stock.
What is Common Stock?
A stock is a share of ownership (equity) in the company that is sold to the general public, through the stock market. When you buy a stock, you essentially purchase ownership in the company. A common stock is a type of stock issued by companies, that comes with its specific share of rights and privileges.
They are named so, as they are the most common type of stocks issued by any company. Usually, its holder has rights to vote for or against certain management decisions of the company. He also has a right to receive a share of profits made by a company, in the form of dividends. A company may also issue a preferred stock, which comes with a different set of privileges.
Sale of these by companies, through an initial public offering (IPO) or a secondary offering, brings in cash only once. Its subsequent resale in the secondary market doesn't bring in any new cash inflow for the company. Stock investing is all about profiting from the variation of stock prices, as they change according to market conditions. The performance and the equity worth of a company is determined by the market value of its common stock.
How is its Issuance Recorded?
If you are learning accounting, you will know that there are specific conventions regarding recording of each financial transaction in the ledger book. Sale of common stock for cash is a transaction that is no exception to this. Here is the procedure for recording it in United States of America. To understand the procedure, you must know what is par value of a stock, its actual value in the market, and the number of stocks that are sold in a single transaction.
Par value of a stock is the price at which the company issues it, while its value is the actual price at which it is sold. Once you have a knowledge of all the above values, you can make an entry into a ledger.
Suppose a company sells 1,000,000 stocks at a par value of USD 2 and its actual sale price is USD 5. Record the transaction type as cash. Make two separate columns for credit and debit. Since the stocks are sold at a market value of USD 5, make an entry under debit as USD 5,000,000. Since the par value of the stock is USD 2, make an entry of USD 2,000,000 under credit column. The difference between the two values is the additional paid-in capital that the company receives due to difference in par value and actual value. In the credit column, this difference of USD 3,000,000 is recorded as additional paid-in capital.
How Does it Benefit a Company?
The benefits of issuing common stock for a company are many. A company may pay off outstanding debts using the additional cash that it receives through the issuance. The cash may also be used for making new acquisitions or funding of new projects. That's why, almost any company that is looking for growth, goes public at some point.
Thus, issuance of common stock has the main function of raising capital for the company. The IPO process is closely monitored by the United States Securities and Exchange Commission (SEC) and is a major milestone in the history of any company as it goes public.