Common stockholders are the owners of public corporations. They are entitled to benefit from the profits generated by the corporation in two ways. The first is through higher stock prices, which can provide a capital gain when the stock is sold. The second benefit is access to dividends. Earnings available to pay dividends to common stockholders are listed in the retained earnings sections of a corporation’s balance sheet.
You can find earnings available for common stockholders in the retained earnings section of a balance sheet.
Earnings and Retained Earnings
Earnings are profits, also known as net income. They are the amount leftover from a period’s gross revenue after recognizing all expenses and losses. Corporations report revenues and earnings each quarter on the income statement. The annual income statement indicates profits for the year.
When a corporation closes out its books for the year, it transfers the annual earnings from the income statement to the retained earnings account on the balance sheet. Retained earnings can then be used to pay dividends or for other purposes, such as capital expenditures or stock buybacks.
The Retained Earnings Formula
Retained earnings contain the net accumulated earnings available to the corporation’s stockholders. The formula for calculating retained earnings (RE) is:
RE = Beginning Period RE + Net Income or Loss - Cash Dividends - Stock Dividends
Net income increases retained earnings whereas dividends drain them. Dividends can take the form of cash or stock. Cash dividends are in the form of cash payments to shareholders, while stock dividends are extra shares issued to stockholders. The dividend yield is equal to the annual dividend amount divided by the stock’s price per share.
Preferred Vs Common Stock
A corporation must issue common stock, and holders of common stock are the owners of the corporation. In addition, the corporation may issue preferred stock, which has characteristics of both stock and debt. Preferred stock pays a fixed dividend each quarter, but preferred stock shareholders do not participate in the governance of the corporation. If the corporation has issued preferred stock, those dividends (which have a different dividend yield from those of common stock) must be paid to preferred stock shareholders before the corporation can pay any dividends to common stock shareholders.
Stockholders’ Equity Section of Balance Sheet
Stockholders share in the equity of a corporation, which is equal to the corporation’s assets minus its liabilities, known as stockholders’ equity. The stockholders’ equity section of the balance sheet lists the value of outstanding shares issued to preferred- and common-stock shareholders, along with additional paid-in capital and retained earnings. Any treasury stock (i.e., shares authorized but not issued) held by the corporation reduces the amount of stockholders’ equity.
Earnings Available for Common Stockholders
The board of directors decides what dividends to pay each quarter. Those dividends come from retained earnings. After paying out any preferred stock dividends, the remainder represents accumulated net income available to common stockholders.
In theory, the board could distribute the entire retained earnings balance to common stock shareholders, but this only happens when a company liquidates. Instead, most dividend-paying corporations like to distribute the same or higher common stock dividends each quarter. Typically, reduced, or omitted dividends indicate financial stress.
Common Stockholders' Claims on the Corporation
If a corporation goes bankrupt and/or liquidates, any remaining value it has is divvied up in an established priority sequence. The IRS, creditors and lenders (from senior to junior) get first dibs on the liquidation proceeds. Next to be paid are any preferred shareholders. The amount they receive is based on the value of the preferred stock, which may require a complex calculation to determine.
If any money remains, it is distributed to the holders of common shares. In other words, common stock shareholders are the last ones to receive liquidation proceeds.
- If a company has no preferred stock, its net income represents its earnings available for common stockholders.
- Calculate a company’s earnings available for common stockholders in previous quarters to identify any positive or negative trends. Increasing earnings available for common stockholders is typically good for a company’s common stock.
- You can also divide earnings available for common stockholders by the number of shares of common stock outstanding -- reported on the balance sheet -- to see how much the company earned for each share of common stock.
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