Simple Capital Structure
A simple capital structure refers to a company’s financial structure that only consists of common stock and no other potential common stock instruments, such as convertible securities, options, or warrants. When a company has a simple capital structure, it means there aren’t any securities or financial arrangements that could potentially dilute or increase the number of outstanding common shares in the future.
In the context of financial reporting, companies with a simple capital structure typically present only basic earnings per share (EPS) in their financial statements. Basic EPS is computed by dividing the net income available to common shareholders by the weighted average number of common shares outstanding during the period.
On the other hand, companies with a complex capital structure (i.e., those with securities like convertible bonds, convertible preferred stock, stock options, or warrants) must present both basic and diluted earnings per share. Diluted EPS takes into account the potential dilution that could occur if all convertible securities were converted into common stock.
Example of a Simple Capital Structure
Let’s take a closer look at a hypothetical scenario to illustrate a company with a simple capital structure.
Scenario: CleanGreen Inc.
CleanGreen Inc. is a startup company focused on eco-friendly household cleaning products. They recently began their operations and have financed their business through equity financing by issuing common stock.
Financial Details of CleanGreen Inc.:
- Net Income for the Year: $300,000
- Common Shares Issued and Outstanding: 100,000 shares
- Other Securities: None. CleanGreen Inc. has not issued any convertible bonds, preferred stock, stock options, or warrants.
Given this information, let’s compute the basic earnings per share (EPS) for CleanGreen Inc.
Calculation:
Basic EPS = Net Income / Average Number of Common Shares Outstanding
= $300,000 / 100,000
= $3 per share
Since CleanGreen Inc. has no other potential common stock instruments (making it a simple capital structure), only the basic EPS needs to be calculated and reported. The basic EPS for CleanGreen Inc. is $3 per share.
Key Points from the Example:
- CleanGreen Inc. has a simple capital structure since it only has common stock and no other potential common stock instruments.
- The calculation for earnings per share (EPS) is straightforward and only requires the basic EPS computation.
- If CleanGreen Inc. had other securities like convertible bonds or stock options, it would have a complex capital structure, and a diluted EPS calculation would also be necessary.
This example demonstrates the simplicity of a company’s capital structure when only basic common shares are in play, without the potential dilution from other securities.
