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1. What Is Common Stock In Accounting

Calculate the amount of equity that the original investors contributed to the company. This value is the product of the number of outstanding shares and the stock price during the original offering. For example, if investors bought 20,000 shares at $30 each, multiply 2,000 by $30 to get $600,000.

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A company’s “earnings available for common stockholders” is the profit it has left over at the end of an accounting period after covering all expenses and paying dividends to preferred stockholders. Common stockholders pay close attention to this figure and to a company’s earnings per share, or EPS, because these numbers represent their cut of the profits. When your small business generates strong earnings available for common stockholders and EPS, you potentially increase the value of your company’s common stock.

Common Stock Earnings Formula

Earnings available for common stockholders equals net income minus preferred dividends. Net income, or profit, equals total revenue minus total expenses. Revenue is the money you earn selling products and services. Expenses are the costs you incur in the same period, such as rent, payroll, interest and income taxes. Preferred dividends represent the portion of profits you distribute to preferred stockholders. Although preferred stockholders receive dividends before common stockholders, they do not share in the rest of the profits; only common stockholders do.

Calculation Example

Assume your small business generates $2 million in total revenue during the year, has $1.7 million in total expenses and pays $20,000 in preferred dividends. Your net income equals $2 million in revenue minus $1.7 million in expenses, or $300,000. Your earnings available for common stockholders equals $300,000 in net income minus $20,000 in preferred dividends, or $280,000. This means each common stockholder has a claim on this $280,000 in proportion to the number of shares he owns. If there are 1,000,000 shares, the earnings per share is 28 cents a share. If a stockholder has 1,000 shares, he has earned $280. Stockholders could elect to reinvest the earnings to improve the profitability of the company.

Uses of Earnings

Although common stockholders technically own the earnings available to them, a business does not necessarily distribute all of this profit. You can choose to pay out a portion of these earnings as dividends to common stockholders and retain the rest, or you can reinvest the entire amount in your business. Using the previous example, your small business might decide to pay out $60,000 as dividends to common stockholders and plow the remaining $220,000 back into your business. This is a business decision that is contingent on a growth strategy or a retention strategy. The early years of a company are usually very growth oriented.

Earnings per Share

You can also calculate your earnings available for common stockholders on a per-share basis – your earnings per share. Earnings per share equal earnings available for common stockholders divided by the number of common shares outstanding. This figure reveals the earnings to which each share of common stock is entitled. Using the above example, assume you have 560,000 shares outstanding. Your earnings per share is 50 cents, or $280,000 divided by 560,000. This means you generated 50 cents of earnings for each share of common stock.

Preferred Stock Earnings

Preferred stock owners don't have voting rights and are similar to bond owners with a fixed dividend paid. This is a higher class of investment compared to common stock. Preferred stock is always paid its dividend prior to earnings calculated and paid to common stock owners. Not every company has preferred stock owners so there are times when common stock earnings is based strictly on the net earnings of the company. A company may establish both preferred and common stock contingent on different offers to investors.

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What Is Common Stock In Accounting

Determining the value of a publicly traded company's shares is a lot easier than those of a small business. With a public company, all you need to do is to look what the shares are currently trading for. Small businesses don't have this luxury. To calculate the value of the common shares for your small business, such as an S-corporation or an LLC, you must first determine the value of the company. You can then divide that value by the number of shares.

Valuation via Multiples of Sales

There are several online resources that will give you a value for a business based on a rule of thumb for its industry based on sales. Here are a few examples of how a company's value varies by industry, according to BizStats.com.

• Accounting firms: 100 to 125 percent of the annual revenue.
  
• Book stores: 15 percent of annual sales, plus its inventory.
  
• Hardware stores: 45 percent of annual sales, plus inventory.
  
• Full-service restaurants: 30 to 35 percent of annuals sales, plus inventory.
  

If, for example, you owned a landscape business, a rule of thumb for that type of business would be 45 percent of annual sales. Thus, if your company brought in $2 million in sales last year, it would be worth $900,000.

Valuation via Comparable Companies

A second method of determining your company's value is to compare it to similar company with a value you do know. This is similar to how homeowners look at what their neighbors' homes are selling for before deciding what their house is worth. To do this, look for a publicly traded company that is in the same industry, with a similar number of employees and revenue as yours. Private companies aren't quite as liquid as public companies, because you can't sell your shares as easily as those that are listed on a stock exchange, so you should reduce the value of your company a bit when using this comparison method.

Valuation via Discounted Cash Flow

When deciding how much a business is worth, Warren Buffett first performs a discounted cash flow analysis. He does this taking the company's revenue and then projecting that into the future, discounted by the long-term interest rates of U.S. Treasury bills. A modified version of Buffett's system is to compare the company's profit to the long-term, T-bill rate. If your business brought in $100,000 of profit in the past year, and T-bills have a return of 3 percent interest, someone who bought your company would make about the same if they had bought $3.3 million in Treasury bills. Of course, this method assumes that your company's earnings will be stable.

Company Stock Value

When all is said and done, the value of your company is what you decide it is – provided someone is willing to pay that price for the shares. Once you have determined the value of your company, you can then divide that by the number of shares. For example, if your company is worth $500,0000 and you and your partners have a total of 50 shares, then each share would be worth $10,000.

If you have yet to divide your company's value into shares, keep in mind that you may be restricted, depending on your company's business structure. An S-Corporation, for example, can't have more than 75 shareholders and can't have shareholders who aren't U.S. citizens. An LLC can have as many shareholders as you would like and don't have restrictions on citizenship.

About the Author

A published author and professional speaker, David Weedmark has advised businesses on technology, media and marketing for more than 20 years. He has taught computer science at Algonquin College, has started three successful businesses, and has written hundreds of articles for newspapers, magazines and online publications including About.com, Re/Max and American Express.