Preferred stock is a type of equity security a company issues to raise money. It sports the name “preferred” because its owners receive dividends before the owners of common stock. On a classified balance sheet, a company separates accounts into classifications, or subsections, within the main sections. Preferred stock is classified as part of capital stock in the stockholders’ equity section. When you review a company’s financials, check out how much preferred stock it uses for financing.
Stockholders’ Equity Section
Stockholders’ equity is funding that a company doesn’t have to pay back. The stockholders’ equity section of the balance sheet lists two main classifications: capital stock and retained earnings. The capital stock subsection includes the money contributed by owners of preferred stock and common stock. Retained earnings represents the profits that have been reinvested into the company. Under capital stock, the money that preferred stock owners have forked over is shown in one or two accounts called “par value” and “additional paid-in capital.”
Corporations assign a par value to each share of preferred stock. This value sometimes represents the initial selling price per share, and is used to figure its dividend payments. A company reports the total par value of preferred stock on the first line of the capital stock subsection. Total par value equals the number of preferred stock shares outstanding times the par value per share. For example, if a company has 1 million shares of preferred stock at $25 par value per share, it reports a par value of $25 million.
Additional Paid-in Capital
If a company sells preferred stock at par value, the par value account is the only preferred stock account on the balance sheet. If it sells preferred stock for a higher price, the extra amount is “additional paid-in capital” and is reported a couple of lines below par value. Using the previous example, assume the company initially sold its preferred stock for $35 million. It would report $10 million in additional paid-in capital because $35 million minus $25 million is $10 million. The total capital given by preferred stock owners is the par value plus the additional paid-in capital, or $35 million.
A company lists various details about its preferred stock on the par value line. Such details might include the dividend percentage, the par value per share, the number of shares allowed to be sold by the company, and the number currently outstanding. A company also sticks additional information in the footnotes to the balance sheet, where it discloses the various features of its preferred stock, such as the ability to convert it into common stock or the preferred stock owners’ rights to receive skipped dividends.
The amount of preferred stock listed in the stockholders’ equity section typically differs from the preferred stock’s market value. Because dividends are paid at a fixed percentage, preferred stock’s market value fluctuates based on factors such as changes in market interest rates. When interest rates are higher than the dividend rate on a company’s preferred stock, the market value is usually less than the amount on the balance sheet. When the dividend rate is higher than interest rates, the preferred stock becomes a hot item, and the market value exceeds the balance sheet amount.
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