Is common stock a current asset? Whether the common stock is a current asset or not depends on who is asking the question. For the issuing company, common stock is equity but for the investor, it could be a current asset. Let us discuss further to understand what common stock and current assets mean so that we can understand why there is a disparity in the classification of common stock between the issuing companies and the stockholders.
What is common stock?
Common stock is a type of stock that represents an ownership stake in the company that issued it. It is a single security instrument that enables its owners to participate in the issuing company through the voting rights which the stocks confer on its holders. The voting rights depend on the number of shares the investor owns as one share is typically equivalent to one vote. Additionally, the stockholders may also get dividend payments.
Companies issue common stock to raise funds which can be used for the acquisition of machinery, business expansion, debt repayment, research and development, etc. Common stocks are considered a source of long-term capital for a business since they typically have no maturity date.
Besides having the right to vote in on matters that require voting and the dividends that they might get paid, holders of common stock have a residual claim on the issuing company’s assets in the case of its liquidation. Additionally, when the company issues new shares in the future, the common stockholders have the right to be first offered these stocks before the company offers them to the public; this is mainly done to prevent stock dilution and is referred to as the first option to buy rights.
Although holders of common stock have an ownership stake in the issuing company, their liability is limited to the initial amount used to purchase the stocks. Based on the number of times a company issues common stock, each stock issued is differentiated by designating a different class to it such as Class A, Class B, etc. Each common stock class usually has unique characteristics that differentiate it from the other classes.
Related: Common stock: Asset or Liability
Common stocks can be issued in any of the following ways:
- Initial public offering: Common stock is usually issued through an initial public offering (IPO) which is generally the first time a private company issues shares to the public. It is known as the going public of a company and is also referred to as a public offer or stock launch.
- Offer for sale: Companies usually have a stipulated number of stocks they can issue which is referred to as the authorized stock. When a company sells its stocks, they are referred to as issued stocks. During the initial public offering, not all the stocks issued get sold, hence the need for the offer for sale. Here, the company offers its already existing stocks for new investors to purchase.
- Stock-based compensation (SBC): This is a situation whereby companies issue common shares to their employees in place of salaries, bonuses, or other work compensations. Another way by which companies do stock-based compensation is by issuing restricted shares or employee stock options.
- Stock exchange introduction: In a stock exchange introduction, the company already has quite a number of stockholders but wants its stocks to trade on major exchanges like NYSE or NASDAQ. With this placing, investors seeking to purchase their stocks can easily find relevant information about the issuing company and also purchase their stocks. In order for this to happen, the company usually has to meet criteria stipulated by the Securities and Exchange Commission (SEC) before they get listed on the stock exchange through a stock broker.
- An original capital infusion: When a startup or a distressed company issues common shares in order to get funding from investors to grow or salvage the business.
- Right or subscription issue: This often uses the common stockholder’s right to purchase new stock issues in order to prevent the stock’s dilution. Hence the company offers its existing holders the new share for them to purchase instead of offering them to the public.
- Stock dividends: This is a situation whereby a company uses common stocks to pay off its debts instead of paying in cash.
See also: Low float stocks
What is a current asset?
A current asset is a type of asset that can be converted to sold or converted to cash within one year; and usually comprises prepaid liabilities, accounts receivable, cash, stock inventory, and short-term investments such as government bonds, high-yield savings accounts, and treasury bills. The accounts receivable comprise monies that clients owe a company which are normally payments for goods or services already offered.
Since a current asset can be sold within a short time frame, it is said to be easily liquid. Hence current assets are liquid assets. A fiscal year is fifty-two to fifty-three (52 – 53) weeks or twelve (12) months which is generally used for accounting and tax purposes. The fiscal year normally ends on the last day of any month apart from December.
Assets are resources that can be a source of future economic benefit to those who own them. They can be tangible such as cash, real estate, plant, furniture, machinery, etc. They can also be intangible such as patents, trademarks, intellectual property, copyright, etc.
Assets generally have a positive economic impact on their owners; they either increase their cash inflow or reduce their cash outflow, thereby bringing value to their owners. As a result of this, the owner is said to enjoy a return on their asset. Assets are resources that a person is owed or owns that are already generating an income or have the potential to generate an income.
Assets can be owned by individuals, partnerships, companies, states, and countries. Companies normally have a record of all their assets. This is recorded on the left or credit side of their books of account. In recent times, the use of technology to prepare the books of account has made it a paged document that lists the assets first followed by the liabilities and then equity.
Another type of asset aside from the current asset is the non-current asset. These are assets that generally require more than one fiscal year before they can be sold. They, therefore, bring value to their owners over a longer period and are not readily liquid. They are also known as long-term assets. Some examples include machinery, real estate, furniture, etc.
A well-known accounting equation expresses assets as Assets = Liabilities + Equity
This equation is the bedrock of the balance sheet and is often used to ascertain a company’s financial standing as the assets of a company when computed are supposed to be equal to the sum of its liabilities and equity.
See also: Growth vs value stocks
Is common stock a current asset?
Common stock could be a current asset for the stockholder since they trade on major exchanges and can be easily sold within one fiscal year just like other current assets. For the companies that issue common stocks, they are classified as equity along with preferred stock and retained earnings on their balance sheet.
As a common stockholder, you own the stocks and they can be easily liquidated. This means you can sell them off within a short time frame depending on the demand for the particular common stock the investor owns. Additionally, when the common stockholders sell them off, they usually get paid a price that is normally higher than their initial investment in purchasing the stocks. The difference between the initial price they bought the stocks and the higher price at which they sell is called a capital gain.
Furthermore, some companies also pay common stockholders dividends annually. Although they only get the dividend payments after bondholders and preferred stockholder have been paid, they tend to benefit more especially if the distributions that have been declared by the issuing company is large. This is because both bondholders and preferred stockholders are entitled to a fixed dividend whereas holders of common stock do not have a fixed dividend, as such, whatever dividend that is leftover gets distributed to the common stockholders of the company and if it is a large sum, they are likely to receive dividends that are higher than that of bondholders and preferred stockholders.
For the issuing company, common stocks are mainly issued to get an influx of funds. The funds gotten from the sales of the stock are recorded as share capital in the equity section of the balance sheet. This capital is then used to boost the business either by expansion, purchasing land, buildings, machinery, or plants, or taking care of other operating expenses. In this way, we could say that although common stock itself might not be considered a current asset by the company, the funds obtained from its sale could be considered a current asset since the funds come in immediately after the stocks are sold and this is generally within one fiscal year.