Definition
Contributed capital, also known as paid-in capital, refers to the amount of money that a company’s shareholders have contributed through the purchase of stock directly from the company. It is a section of the shareholder’s equity found on the balance sheet and reflects the amount of funds generated by the sale of equity shares. It differs from earned capital, which is generated through the company’s operating earnings.
Phonetic
The phonetic spelling for “Contributed Capital” could be written as: kuhn-trib-yoo-ted kuh-pi-tuhl
Key Takeaways
Contributed Capital, also referred to as paid-in capital, is the financial resources that a company receives from investors in exchange for shares. Here are three main takeaways about Contributed Capital:
- Source of Funding: Contributed Capital represents the funds that a corporation receives from selling its shares to investors. Unlike borrowing funds, this capital does not have to be repaid, making it a crucial source of financing for many companies.
- Impact on Shareholder’s Equity: Contributed Capital is a component of shareholders’ equity. It is combined with retained earnings (or net income retained within the company) to form the total shareholders’ equity of a company.
- Accounting Practices: In financial accounting, Contributed Capital is documented on the balance sheet under shareholders’ equity. It reflects the total value of shares that have been purchased directly from the company itself, distinguishing it from those bought from other shareholders in the marketplace.
Importance
Contributed capital, also known as paid-in capital, is important in the business and finance domain because it represents the amount of money invested by shareholders into the business. It reflects the commitment of shareholders to the long-term growth and success of the company. The larger the contributed capital, the more resources a company typically has to use for operational activities, expansion, investments, and paying off debt. As a key component of shareholder’s equity on a company’s balance sheet, contributed capital is essential for understanding the company’s funding structure and its reliance on investor financing versus earned profits, giving important insights to investors and other financial stakeholders.
Explanation
Contributed Capital, often referred to as paid-in capital, is a crucial component for any organization as it denotes the amount of cash or other assets that shareholders have given a company in exchange for equity shares. This capital essentially serves as the foundation upon which a company builds its operations, and it plays a pivotal role in determining a company’s financial health. The purpose of contributed capital is to fund a company’s start-up costs, ongoing operations and growth ambitions. For start-ups and even for established companies, this fund is particularly meaningful as it allows them to make necessary strategic investments, settle their liabilities, and mitigate solvency issues. For any business, the ability to generate contributed capital is a fundamental aspect of their existence and growth. For example, by selling stock directly to investors, the company obtains the necessary funds for business expansion, research and development projects, or even to offset debts. In terms of its use in financial accounting, contributed capital is recorded on a company’s balance sheet under shareholders’ equity, giving prospective investors and business partners tangible proof of the business’ financial stability and the level of investor commitment. It’s crucial in determining return on equity, which is a key metric used by investors to judge a company’s performance.
Examples
1. **Establishing a Start-up Company**: A group of investors comes together to establish a tech start-up. Each investor contributes a certain amount of money toward the startup’s funding. For instance, Investor A gives $2 million, Investor B gives $3 million, and Investor C gives $5 million. Together, these funds totalling $10 million becomes the start-up’s “contributed capital”. 2. **Investment in a Public Corporation**: An individual buys 100 shares of a publicly-traded corporation, such as Apple, at $120 per share. The total amount of money they spent, $12,000, is actually a form of contributed capital to Apple. They are now a shareholder and owns a small fraction of the corporation.3. **Venture Capital Funding**: A venture capital firm decides to fund a promising but risky biotech company. The VC firm provides $50 million in capital as a long-term investment. This inflow of capital is recorded on the biotech company’s balance sheet as contributed capital.
Frequently Asked Questions(FAQ)
What is Contributed Capital?
Contributed capital, also known as paid-in capital or share capital, refers to the amount of money that a company’s shareholders have paid for their shares during the initial issuance or the subsequent transactions.
How is Contributed Capital recorded?
Contributed Capital is recorded in the shareholders’ equity section of a company’s balance sheet. It’s usually broken down into common stock and additional paid-in capital accounts.
How does Contributed Capital differ from Earned Capital?
Contributed Capital comes from shareholders when they purchase company’s shares, while earned capital is generated from the company’s operations and activities, typically in the form of retained earnings.
Does Contributed Capital affect the income statement?
No, contributed capital is an equity item and does not directly affect the income statement. It only indicates the cash or other assets that shareholders have given a company in exchange for stock.
Can Contributed Capital value decrease?
While the value of contributed capital does not typically decrease, under certain circumstances like when a company decides to buy back shares, the total amount of contributed capital might decrease.
Is the Contributed Capital returned to shareholders when the company shuts down?
In case of liquidation, after paying off its liabilities, whatever remains is returned to shareholders. However, these amounts may be lesser than the contributed capital, depending on the financial situation of the company at that time.
What is the role of Contributed Capital for a company?
Contributed capital is essentially the amount that shareholders have invested in the company. It provides necessary capital for the company to fund its operations or expand its business. It’s also an important element in calculating return on equity.
Does more Contributed Capital mean more profit for a company?
Not necessarily. While more contributed capital may provide more resources for a company to use in its operations or expansions, it does not guarantee more profits. Profitability depends on various factors including the company’s efficiency, strategy, market dynamics, etc.
Related Finance Terms
- Equity Financing: Money raised by a business in exchange for a share of ownership in the company. This involves the distribution of shares to increase a company’s equity, or contributed capital.
- Retained Earnings: Profits that the company decides to keep or ‘retain’ rather than distribute to shareholders, which are then added to the company’s contributed capital.
- Stockholders’ Equity: The amount of capital given to a business by its shareholders, along with its retained earnings.
- Initial Public Offering (IPO): A type of public offering where shares of a company are sold to institutional investors and then made available for sale to general public, resulting in contributed capital.
- Share Premium: The amount that a company raises on shares over and above their face value, which also forms part of a company’s contributed capital.
