Unpacking the Confusion: Authorized Capital and Paid-Up Capital in Company Finance
When it comes to company finances, two terms that often cause confusion are Authorized Capital and Paid-Up Capital. Many individuals tend to use these terms interchangeably, but in reality, they are two distinct concepts. While both terms are related to the capital structure of a company, they have different implications and play different roles in determining the financial stability of a company. In this article, I aim to provide a clear and concise explanation of these two terms to help eliminate any confusion and provide a better understanding of the subject.
Authorized Capital: Authorized capital refers to the maximum amount of capital that a company is legally allowed to issue as per its memorandum of association (MOA) and articles of association (AOA). It is the upper limit set by the company’s founding documents and is used as a measure of the company’s financial strength.
Paid-Up Capital: Paid-up capital is the actual amount of capital that a company has received from its shareholders in exchange for shares. This amount is a subset of the authorized capital and is considered as the actual capital of the company. The paid-up capital represents the funds that are actually available for the company’s use and is a crucial factor in determining the financial strength of a company.
A company can increase its authorised capital by taking approvals from the board members. Paid-up capital is part of the authorised capital. While assessing the networth of a company only Paid-up capital is considered.
Example: Suppose a company in India has authorized capital of INR 100 crores and has issued 10 crore shares at a face value of INR 10 each. The company has received full payment for these shares, which means the paid-up capital of the company is INR 100 crores. In this case, the company has utilized its entire authorized capital, and the paid-up capital is equal to the authorized capital.
In simple words, the highest amount of money a company is allowed to raise by selling shares is Authorised Capital and Paid-Up Capital is the actual amount of money a company has raised by selling shares to investors. The difference is “allowed to raise” and “has raised”.
Authorized Capital and Paid-Up Capital are required for several reasons:
- To provide a legal framework for issuing shares: Authorized capital serves as a legal limit for a company to issue shares to raise capital. It provides a framework for the company to issue shares in a regulated manner and helps prevent over-issuance of shares, which could lead to financial difficulties.
- To raise funds: Paid-up capital is the actual amount of capital that a company has received from its shareholders in exchange for shares. This amount is used by the company for its operations and growth.
- To determine the financial strength of the company: The difference between the authorized capital and paid-up capital provides an insight into the company’s financial strength. A high paid-up capital compared to the authorized capital indicates that the company is financially strong, while a low paid-up capital compared to the authorized capital may indicate financial difficulties.
- To provide a basis for valuation: The authorized capital and paid-up capital serve as a basis for the valuation of a company. The value of the company’s shares is often based on the number of shares issued and the paid-up capital of the company.
In conclusion, Authorized Capital and Paid-Up Capital are two important aspects of a company’s financial structure. Authorized Capital represents the maximum amount of capital that a company is legally allowed to issue, while Paid-Up Capital represents the actual amount of capital that the company has received from its shareholders in exchange for shares. Understanding the difference between these two terms is crucial for investors and stakeholders as it provides an insight into the financial stability and strength of a company.