As a new investor exploring the world of finance, it’s crucial to understand the concept of paid-up capital. Paid-up capital meaning is the sum of money that a company gets from shareholders in exchange for ownership of shares. It serves as a critical indicator of a company’s financial strength, stability, and value.
Think of this way as putting your money into a piggy bank that the company can use to run its business and make investments.
So let’s begin to understand this concept in detail and understand what do you mean by paid up capital by looking at the paid up capital definition.
What is Paid Up Capital Meaning in Banking?
The meaning of paid up capital refers to the portion of a company’s authorized capital that a company has received from shareholders in exchange for shares. It represents the actual equity investment made by shareholders in the company. Simply put, a company creates paid-up capital by directly selling its shares to investors in the primary market. Furthermore, this is usually through an Initial Public Offering (IPO). When investors buy or sell shares on the secondary market, they do not add any additional paid-up share capital. This is because those transactions come under selling shareholders and not the issuing company.
The paid up capital formula is as follows:
Paid up capital= Par value of shares + Additional paid-in capital
What is Paid Up Share Capital Meaning?
Paid-up shares capital, also known as contributed capital, originates from two main sources. These sources are: the premium value of the stock and the par value of the shares. The par value, representing the base price of each share, is generally low. Shareholders who pay an amount surpassing this par value contribute to additional paid-up capital. The balance sheet, specifically the preferred stock section, reflects this information. To comprehend paid-up capital, one must delve into an understanding of share capital.
Within 60 days of incorporation, companies must issue shares, determining the paid-up capital in the process. The company allocates the funds received to cover operational expenses.
For a company to go public, approval from the Securities Exchange Board of India (SEBI) is necessary. Only after SEBI grants permission can the company proceed with an Initial Public Offering (IPO) to issue its shares to the public.
What are the Key Components of Paid Up Capital?
Here we have listed out the key components of paid-up share capital are:
- Equity Shares: Most common type of shares. Equity shares represent ownership in a company and entitle the holder to a share of the company’s profits. It is one of the key components of paid up equity capital.
- Preference Shares: Preference shares offer certain preferential rights over equity shares. For example, preference shareholders may receive a fixed dividend, or they may take priority over equity shareholders in the event of a liquidation.
- Retained Earnings: Profits that a company has earned but has not yet distributed to shareholders. Retained earnings can be used to finance future growth, or they can be distributed to shareholders as dividends.
- Share Premium: The amount of money that shareholders have paid above the par value of a share. This is the amount of money that a company receives from investors as a premium.
Retained earnings do not appear in the paid-up capital on the balance sheet, but they constitute a component of the paid-up capital when calculating the company’s equity.
Paid Up Capital vs. Authorized Capital
When a company wants to raise equity in exchange for money, it cannot simply sell off all its shares to the highest bidder. Therefore, companies request a governing body called SEBI (Securities and Exchange Board of India) to issue public shares by filing an application. Thus, the maximum amount of shares that a company is allowed to issue is called authorized capital. It is the total number of shares that the company has authorized its board of directors to issue.
However, it’s essential to note that authorized capital does not represent the actual money invested in the company. It’s just the maximum amount the company can legally collect. The actual amount of money invested by shareholders is called paid up capital.
Here we have summarized the key differences between paid up capital and authorized capital:
|The amount of money that a company has actually received from investors in exchange for shares.
|The maximum amount of shares that a company is allowed to issue.
|Par value of shares + Additional paid-in capital
|Number of authorized shares * Par value of shares
|Indicates the actual money invested by shareholders
|Sets the limit for the company’s fundraising potential
|More important financial metric
|Less important financial metric
|Assess a company’s financial strength and calculate financial ratios
|Determine how much more capital a company can raise by issuing new shares
How Does Paid Up Capital Work?
There are two sources of paid up capital – the face value of the stocks and any excess capital paid on top.
- The Par value of shares is the nominal or face value of a share. It is the minimum amount that a company must receive from investors when they purchase a share.
- Additional paid-in capital is the amount that investors pay above the par value of a share. This is the amount of money that a company receives from investors as a premium.
Let’s say a company issues 100 shares with a par value of ₹10 each. If the shares are sold for ₹15 each, then the paid up capital would be ₹1500. This means that investors paid ₹15 per share, which is ₹5 above the par value. Thus, it would consist of ₹100 in common stock and ₹1500 in excess.
What is the Importance of Paid Up Capital?
The term paid up capital of a private company refers to the money that has not been borrowed. So if fully paid-up companies have already sold all their shares, they cannot increase their capital unless they take on debt.
Here are some of the reasons why paid up capital is important:
- It is a measure of a company’s financial strength. The higher the paid up capital means the more financial resources the company has to operate and grow.
- It is used to calculate financial ratios. The debt-to-equity ratio and the equity ratio are two important financial ratios that are used to assess a company’s financial health. The paid up capital is a key component of these ratios.
- It is used to determine a company’s creditworthiness. Lenders and other creditors use the paid up capital to assess a company’s ability to repay its debts. A higher paid up capital indicates that a company is more likely to be able to repay its debts.
- It is used to determine a company’s eligibility for certain types of financing. Some types of financing, such as initial public offerings (IPOs), require a minimum amount of paid up capital.
Importance of Paid Up Capital for Businesses
Businesses often require additional equity for various reasons, such as covering unforeseen operational costs or establishing infrastructure for expansion. Raising paid-up capital offers a borrowing-free avenue to generate funds, eliminating the associated interest costs that can erode profit margins and extend a company’s debt over time.
What are the Characteristics of Paid Up Capital?
Let’s have a look at the characteristics of this capital:
- Non-Current Asset: This means that it is not expected to be converted into cash within one year.
- Classified As Equity: Known as equity paid-up capital meaning in banking. This means that it is a claim on the company’s assets by the shareholders.
- Fully Paid by Shareholders: Paid capital meaning indicates that shareholders have paid the entire amount for the shares they purchased, fulfilling their financial obligation to the company.
- Enhances Financial Stability: Paid up capital of a public company contributes to the company’s financial strength and stability, acting as a cushion against potential losses or liabilities.
- Indicates Shareholder Ownership: Paid up capital represents the ownership stake of shareholders in the company, entitling them to voting rights and a share in profits.
- Reflects Investor Confidence: A higher paid up capital indicates a greater level of investor confidence in the company’s prospects and financial soundness.
- Impacts Creditworthiness: A higher paid-up share capital enhances the company’s ability to borrow funds and negotiate favourable terms.
- Meets Legal Requirements: Many jurisdictions have minimum paid up capital requirements that companies must fulfil to operate legally, ensuring they have sufficient resources to meet obligations.
- Subject to Change: Paid-up total share capital can change over time due to various factors. Factors such as, issuing new shares, repurchasing shares, or capitalizing retained earnings.
Paid Up Capital Example
Assume that XYZ Pvt. Ltd. has an authorized capital of ₹10,00,000 divided into 1,00,000 equity shares with a face value of ₹10 per share. Here’s how the paid up capital can be calculated:
Suppose investors subscribe and fully pay for 50,000 equity shares at the face value of ₹10 per share. Then according to the paid up capital formula, the paid up capital of a private company named XYZ Pvt. Ltd. would be:
Paid-up Capital = Number of Shares Issued × Face Value
= 50,000 shares × ₹10 per share
Therefore, in this example, the paid up capital of XYZ Pvt. Ltd. would be ₹5,00,000.
Remember, this is just a hypothetical example. The actual paid up capital of a company can vary depending on various factors. Such as, the number of shares issued and the price at which they are issued to shareholders.
What is Authorized Capital?
The firm’s authorized share capital, as outlined in the Memorandum of Association under the “Capital Clause,” sets the limit for shares the company can issue to stockholders. Notably, this capital is determined before the establishment of the firm and can be raised later through legal processes.
For example, if ABC Pvt Ltd has an authorized capital of Rs. 15L and has already issued shares worth Rs. 10L, it has reached the maximum allowed limit. However, the company can still release additional shares, up to Rs. 5L, without increasing the authorized amount of capital.
Conversely, if ABC Pvt Ltd issues shares totaling Rs. 20L with an authorized capital of Rs. 15L, it exceeds the legal limit, which is not permitted.
Difference Between Authorized Capital vs Paid Up Capital
Here a comparative analysis of Authorized Share Capital vs Paid Up Share Capital:
|Aspects of Differences
|Paid Up Capital
|Maximum capital a company can raise through the issuance of shares, as specified in the company’s charter.
|The portion of the authorized capital that shareholders have actually paid for and infused into the company.
|Can only be altered through a formal process, often requiring approval from regulatory authorities and shareholders.
|Changes can occur as shares are issued, and shareholders contribute funds to the company.
|Represents the upper limit for future capital needs, providing flexibility for potential expansions.
|Reflects the actual funds infused into the company by shareholders.
|Serves as a potential reservoir for future growth, demonstrating the company’s capacity for expansion.
|Indicates the tangible financial commitment of shareholders, contributing to the company’s financial health.
To Wrap It Up…
In conclusion, paid up capital serves as a fundamental element of a company’s financial structure. It represents the actual equity investment made by shareholders. Additionally, it plays a vital role in determining financial stability, creditworthiness, and investor confidence. With its impact on company valuation, legal compliance, and financial decision-making, understanding and effectively managing paid up capital are crucial for businesses aiming to thrive in the dynamic marketplace.
Paid-up capital meaning is the sum of money that a company gets from shareholders in exchange for ownership of shares.
The Paid-up capital formula is as follows: Paid up capital = Par value of shares + Additional paid-in capital
The ‘paid-up share capital’ of a company represents the money received from shareholders after issuing shares and receiving payment.
A corporation cannot withdraw money infused as paid-up capital unless it has a valid business need.
The issued share capital represents the total shares a company has distributed to its shareholders.
Companies may not have fully paid for these shares, unlike paid-up capital.
Creating a Private Limited Company in India still necessitates an authorized capital of Rs. 1 lakh, but since 2015, there is no longer a mandatory minimum post issue paid up capital.
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