Authorized and paid-up capital are essential components of a corporation’s capital structure within the scope of corporate finance.
It is important to be aware of both since both comprise financial strength and also the capability of raising funds through the capital structure for various businesses, though used on different purposes and, more importantly, are handled differently by businesses.
Let us discuss both the terms, note what makes them distinguishable from each other, and appreciate what these concepts mean in their contexts for businesses concerned.
What is Authorized Capital?
Authorized capital, also known as nominal capital or registered capital, is the maximum amount of capital that a company can issue to its shareholders as per the charter documents.
It is the maximum number of shares that a company can legally issue, an amount determined at the time of incorporation. However, the authorized capital is not absolutely fixed. It may also be increased later when the need for increasing capital arises.
This is the absolute amount of share value a firm is allowed to raise but it is not compulsorily issued at one time.
Example: If authorized capital of a firm is $1 million, then the firm can raise as much as $1 million worth of shares, though it can even raise less initially.
Key Points:
• Decided legally at the time of incorporation.
• It can be increased but through board approval
• It fixes the maximum limit of issuing shares.
What is Paid-Up Capital?
Paid-up capital refers to the amount a company really receives from shareholders as a trade for shares issued.
It is the actual funds owned by a company for running and further growth and other activities. Paid-up capital, unlike authorized capital, shows the actual investment that has been made by shareholders in the company.
For instance, if a company has issued shares worth $500,000 out of its $1 million authorized capital, then the paid-up capital will be $500,000.
Key Points
• Comprises the cash raised from shareholders.
• Indication of investment in the company and liquidity.
• Cannot exceed authorized capital.
Key Differences
|
Feature |
Authorized Capital |
Paid-Up Capital |
|
Definition |
Maximum amount share capital a company can issue |
Actual share capital paid for by shareholders |
|
Purpose |
Determines legal amount a company can issue |
Represents real money that a shareholder has invested |
|
Adjustability |
Can be enhanced through approval of the regulators |
Limited by authorized capital |
|
Reflective |
Value Potential share capital |
Actual funds that are held by the firm |
|
Initial Requirement |
Determined at the time of formation |
Dependent on shares that have actually been issued |
Why to Know Both Concepts
1. For Investors: Understanding the distinction helps investors to analyse the growth possibilities of a company. Big authorized capital with relatively low paid-up capital can indicate available future share issue and consequently, dilution.
2. For Businesses: Correctly managing authorized and paid-up capital helps a company maintain growth along with shareholder equity.
3. For Compliance: Both figures have to be declared in the annual filings of a company, thus showing transparency in the financial standing of the company.
Real-World Example
Let us consider a start-up which has authorized capital of $2 million. At the initiation stage, it issues shares only to the tune of just $500,000 as paid-up capital while keeping full liberty to raise more money by issuing more shares at some point in the future.
It can either issue more shares up to the authorized limit while growing business or the company may increase its authorized capital to raise more investment in order to meet the needs.
Conclusion
Authorized capital represents the highest potential share capital a company can issue. Paid-up capital shows the amount of money received by a company.
This knowledge is highly essential for the people involved with corporate finance, investment, and managing companies; as these two determine how much a company can grow, the degree of control the shareholders have on the company, and whether or not the company is financially sound.