Capital increase from accumulated profit (formula, advantages and disadvantages)

• What are the advantages and disadvantages of increasing capital from the accumulated profit?
• What is the number of shares after the capital increase from the accumulated profit?
• How is the stock price after the capital increase from the accumulated profit?
• How long does the process of raising capital from retained earnings take?

What is capital increase from retained earnings?

Capital increase from the place of accumulated profit is one of the types of capital increase methods in which a joint stock company keeps a percentage of the profit from its economic activities in an account called accumulated profit. If the accumulated profit of a company is significant, it can be used as a source of capital increase of that company. In this method, the mentioned amount is divided among the shareholders in proportion to the share of each shareholder. In order to learn all these concepts, we suggest you to participate in the fundamental analysis course of Rahvard Academy.

Because in the method of capital increase from the place of accumulated profit, shareholders receive profit without entering new liquidity into the company, this type of stock is also called bonus stock. It should be noted that in the method of increasing capital from the accumulated profit, the ownership percentage of the shareholders does not change, but the value of their shares decreases. In other words, there will be no change in the total assets of the shareholders.

Benefits of capital increase from accumulated profit

Increase the number of shares of shareholders

One of the most important benefits of increasing capital from retained earnings is increasing the number of shares. But in fact, in terms of the value of the shares, there will be no change in the shareholders’ portfolio, and on the same basis, the price of each share will also decrease.

Ensuring that the company is profitable

If a company intends to increase its capital, of course, it must accumulate profit from the sale of products or non-operating profit over a certain period of time. Then, it offers this accumulated profit to the shareholders under the title of capital increase.

Helping to make the company profitable in the medium and long term

Capital increase from the place of accumulated profit is an important fundamental act in the analysis of shares. Another advantage of this method is that, if nothing special happens, the profitability of the company will be repeated.

Accelerating the development plans of the company

Another advantage of increasing capital from the accumulated profit is that the development plans of the company, such as launching a new production line, and consequently, increasing the company’s production and profit, will be accelerated.

No need to pay for bonus shares

Unlike the pre-emptive shares, which require the payment of the price, in the method of capital increase from the accumulated profit, the shareholder is not required to pay money in exchange for the bonus shares.

Disadvantages of capital increase from retained earnings

Locking a percentage of the property for one to two months

One of the most important risks of buying shares that have a capital increase from the place of accumulated profit is the locking of shareholders’ assets to the extent of the percentage of capital increase. In fact, the shareholder must not need his money for at least 2 months to be able to purchase such a share.

A stock price crash after the locked-in asset is released

In the capital increase method from the accumulated profit, a part of the shareholder’s property is locked. But when the asset becomes salable after two months, there will be a lot of supply from the shareholders who may not be able to sell their shares again and its value will be less and less every day.

Failure to inject liquidity into the company

In the method of capital increase from the place of accumulated profit, unlike the capital increase from the place of cash receipts and receivables, new liquidity does not enter the company’s account. Rather, the capital increase from the accumulated profit is the result of the company’s savings in recent years.

Not applicable for all companies

Capital increase from the place of accumulated profit cannot be used for companies that do not have adequate efficiency and profit, and it is applicable only for companies that have significant accumulated profit.

The number of shares after capital increase from retained earnings

When a company raises capital from retained earnings, a number of bonus shares are added to the portfolio of that company’s shareholders. But as mentioned at the beginning of this article, with the allocation of bonus shares, the value of the shareholders’ portfolio will not change.

Share price after capital increase from accumulated profit

The share value follows the following formula:

                    (share price)   X (number of shares) = share value          

According to the above formula, you can see that in order to keep the stock value stable, as the number of shares increases, its price must decrease. As bonus shares are added to the portfolio of shareholders, their share value does not change, therefore, despite the increase in the number of shares, the price of each share decreases to keep the share value constant.

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How long does the process of raising capital from retained earnings take?

Regarding the duration of the capital increase from the accumulated profit, it is necessary to know that the decision regarding the capital increase from the accumulated profit and the minutes of the meeting will be signed by the chairman of the assembly in the extraordinary general assembly. Then, this minutes should be delivered to the Companies Registration Office within a maximum period of one month.

Conclusion

The need of joint-stock companies licensed to operate in the stock market to develop new financial resources arises for various reasons, the most important of which are: development of the company’s activities, gaining the ability to compete with other companies or seeking superiority over them, and reforming the financial structure of joint-stock companies.

According to the company’s conditions and goals, capital increase can be done in these four ways: capital increase from the place of cash receipt and collection of claims (preemptive right), capital increase from the place of accumulated profit (bonus shares), capital increase from the place of spending shares and Capital increase from revaluation of assets. In order to learn more about this topic, we suggest you read the fundamental analysis training article