Ever wondered what holds up the financial infrastructure of a corporate institution? It’s the scaffoldings of different types of capital that support a company’s monetary foundation. When it comes to understanding the financial structure of a company, two terms often emerge – authorized capital and paid-up capital. These two, although interrelated, are fundamentally different in meaning and function.
The concept of authorized capital, adhering to the Dow Theory, is linked to the overall growth of a company. As per the Dow Theory, the market price of a share is determined by the company’s present and future earning capacity. Here, authorized capital plays a crucial part. It is the maximum amount of share capital or equity capital that a company is authorized by its constitutional document to issue (sell) to shareholders. The authorizing document, known as the Memorandum of Association, indicates the limit up to which a company can issue shares.
Take, for example, if a company in India has an authorized capital of INR 1 crore, it means that the company, based on its Memorandum of Association, is allowed to issue shares up to the value of INR 1 crore. The company, however, at its own discretion, can decide not to issue the entire amount of authorized capital. It can increase or decrease its authorized capital during its lifetime under the provisions of the Companies Act, 2013. Therefore, the concept of authorized capital implies that a company has a prescribed limit of capital issuance, which could be upscaled, depending on its present financial decision, the guideline of Dow Theory, and the directives of the Indian Companies Act.
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Conversely, paid-up capital, still adhering to the Dow Theory, is the amount of money a company has received from shareholders in exchange for shares of stock. It is a portion of the authorized capital and refers to the total amount of shares that shareholders have fully paid for. If the company’s authorized capital is INR 1 crore, and it has raised INR 50 lakhs by issuing shares, then INR 50 lakhs will be the company’s paid-up capital. Hence, paid-up capital reflects how much of the authorized capital has been utilized in selling the company’s shares.
A company’s paid-up capital can be less than its authorized capital, but it can never exceed the authorized capital. For instance, if a company’s balance sheet reads a paid-up capital of INR 60 lakhs out of an authorized capital of INR 1 Crore, it indicates that the company hasn’t yet issued shares to the full extent of its authorized capital.
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Understanding the distinctions and relations between authorized and paid up capital is crucial. It helps investors discern the potential growth of the company by observing changes in authorized capital alongside implementing the Dow Theory to predict share prices.
If a publicly-traded company decides to increase its authorized capital, it could mean that the company might be planning for expansion, paying off debts, or investing in new projects. An increase in paid up capital, on the other hand, signifies that the company is bringing more equity into the business which can mean stronger financial health.
Investing based solely on authorized and paid up capital can be treacherous. The Dow Theory, used alongside other fundamental and technical analysis tools, can assist in making informed financial decisions. However, it’s essential to analyze other factors like a company’s earnings, assets, liabilities, and market conditions to make an all-round informed investment decision.
Disclaimer: Investing in the stock market involves risk, and investors should consider all aspects and consult with a certified financial advisor before making any investment decisions. The information provided in this article is for informational purposes only, and is not intended as investment advice or a guarantee of any specific outcome. The investor must gauge all the pros and cons of trading in the Indian stock market.