Capital Surplus

Capital Surplus

Definition

Capital surplus is the extra money a company raises by issuing stock above its par value.

 

Description

Capital surplus is like having extra money left over after all your bills and expenses are paid. It's the amount of money a company has beyond what it needs for regular operations. This surplus can come from selling stocks or assets for more than they cost. Think of it as a reserve fund that a company can use for future investments or to cover unexpected costs.

Five ways capital surplus can be created include:

1. From stock issued at a premium to par or stated value (most common)
2. From the proceeds of stock bought back and then resold
3. From a reduction of par or stated value or reclassification of capital stock
4. From donated stock
5. From the acquisition of companies that have capital surpluses

Although item 1 is the most common, items 2 and 5 should be noticed.

Public companies have repurchased significant common stock over the last decade through share repurchase programs. 

In the future, to raise capital, these businesses could reissue treasury stock.

An uptick in M&A could also see more companies adjusting their balance sheets to account for capital surplus-related accounting issues.

Capital stock can serve as an umbrella term for more specific classifications, such as acquired surplus, additional paid-in-capital, donated surplus, or revaluation surplus (which could pop up during appraisals).

Importance of Surplus Stocks

Here are some simple points explaining the importance of capital surplus:

1. Financial Stability: Capital surplus meaning for a company shows that it has money beyond its immediate needs. This provides a safety net in case of unexpected expenses or economic downturns.
2. Investment Opportunities: Capital surplus can be used to fund new projects, invest in research and development, or expand the business. It provides resources for growth and innovation.
3. Debt Reduction: Surplus funds can pay off debts or loans, reducing the company's financial liabilities and improving its creditworthiness.
4. Shareholder Value: Investors often view companies with capital surplus favourably. It can lead to higher stock prices and dividends, increasing shareholder value.
5. Flexibility: Having extra capital gives the company flexibility in decision-making. It can seize opportunities, weather economic challenges, or invest in strategic initiatives without relying solely on external financing.
6. Risk Management: Capital surplus is a buffer against unexpected events such as economic recessions, market fluctuations, or operational setbacks. It enhances the company's ability to withstand risks.
7. Attractiveness to Stakeholders: Lenders, suppliers, and potential partners may view a company with a healthy capital surplus as a more reliable and attractive business partner.

How to calculate Capital Surplus?

These are the steps you can follow to calculate Capital Surplus:

Step 1: Gather Information: To calculate capital surplus, this is what you will need:

• Par Value per Share: This is the face value of a stock, typically a fixed amount set by the company during its incorporation. You can find this in the company's financial statements or prospectus.
• Issued Share Price: This is the actual price at which the company sells its shares to investors. It can be found in public offering documents or financial news for publicly traded companies.

Step 2: Calculate the Difference: After both values, subtract the par value per share from the issued share price.

Formula:

Capital Surplus per Share = Issued Share Price per Share - Par Value per Share
 

Step 3: Multiply for Total Surplus (Optional): To find the total capital surplus for the entire stock issuance, multiply the capital surplus per share by the total number of shares issued.

Example:

Suppose a company issues 1,000 shares of common stock with a par value of Rs.10. What is the capital surplus if the shares are sold for Rs.15 each?

• Capital Surplus per Share = Rs.15 (issued price) - Rs.10 (par value) = Rs.5 per share
• Total Capital Surplus (assuming all 1,000 shares issued) = Rs.5 per share * 1,000 shares = Rs.5,000

Do not MISS This:

• Capital surplus is only generated when the issued share price exceeds the par value. There's no capital surplus if the share price is equal to or lower than the par value.
• Capital surplus accounts within the shareholder's equity section of the company's balance sheet.

Trends that can affect the computation of Capital Surplus

These are the trends that can affect the computation of Capital Surplus:

Stock Splits and Stock Dividends:

• Stock splits and dividends don't directly affect the total capital surplus amount. However, they can impact how it's represented on the balance sheet.
• The par value and issued price per share are proportionally reduced in a stock split. While the total capital surplus remains unchanged, it's now spread across more shares.
• If paid in cash, stock dividends can reduce the capital surplus by the amount distributed to shareholders. However, it's more common for stock dividends to be issued as additional shares. Like stock splits, this doesn't change the total capital surplus but dilutes its representation per share.

Treasury Stock Buybacks:

• When a company repurchases its shares (treasury stock), it can affect the capital surplus depending on the repurchase price.
• The difference can be deducted from the capital surplus if the treasury stock is repurchased at a price above its par value. This reflects the company essentially buying back its own capital.
• Repurchasing treasury stock at a price below par value can increase capital surplus, but this scenario is rare.

Accounting Rule Changes:

• Changing accounting standards can impact how companies report certain financial elements.
• In rare cases, regulatory bodies might introduce new accounting rules that redefine the treatment of capital surplus. This could involve merging it with other shareholder equity accounts or changing how it's calculated based on new valuation methods.
  
   

Example

Consider Bajaj Finance, India's leading non-banking financial company (NBFC). Here's a hypothetical scenario to illustrate capital surplus:

• Par Value: Assume Bajaj Finance issues common stock with a par value of Rs. 10 per share.
• Issued Share Price: Suppose during an initial public offering (IPO), Bajaj Finance sells these shares for Rs. 75 each.

So we can calculate Capital Surplus per Share:

Capital Surplus per Share = Issued Share Price - Par Value

= Rs. 75 - Rs. 10

= Rs. 65 per share

Impact on Bajaj Finance:

Bajaj Finance generates a capital surplus of Rs. 65 for each share issued by selling shares above par value. This represents the extra funds raised from investors who believe the company's stock is worth more than its base price.

FAQ

What is capital surplus?

A capital surplus is a firm's excess amount of funds after meeting its financial obligations and operating needs. It is the additional funds required for day-to-day operations.
 

How is the capital surplus generated?

Capital surplus can be generated in various ways, including selling corporate assets for a profit, issuing shares at a premium, and collecting additional capital contributions from investors over the par value of the shares.

What is the significance of capital surplus?

Capital surplus is essential because it allows a corporation to maintain financial flexibility and stability. It can be utilised for strategic investments, debt reduction, shareholder payouts, or to cover unexpected expenses.
 

How does capital surplus differ from retained earnings?

While capital surplus and retained earnings are accumulated funds within a corporation, they come from various sources. Capital surplus often results from transactions such as stock issuances, whereas retained earnings are profits created by the company's operations over time.