[MUSIC] Hi everyone. As we start our conversation about equity, you can think of the company's equity as its net worth, or the amount that owners of the company have a claim to. We noted at the beginning of the course, that equity is mathematically the difference between the company's assets and its liabilities. But conceptually, we can think of the company's net worth consisting of two parts, the value that owners contributed to the company and the accumulation of what the company has earned since it's began doing business. Let's take a look at these two parts of equity beginning with the contributions from the owners. If we looked at the equity section of a balance sheet from Missy, we would probably see a line item called capital contributions, which would list the value of that Missy and her brother contributed to Sweet Indulgence. They're the only two investors in the company which makes their contributions easy to track and understand. However, you're likely to encounter about balance sheet with an equity section that looks like this. This is the equity section of a company that is organized as a corporation rather than as a simple partnership. When a company needs a lot more capital or funds than a company like Sweet Indulgence, it often seeks to attract a lot more partial owners. We call these partial owners shareholders because they contribute capital to the company in exchange for some share of ownership in the company, we call these shares of ownership, stock. As we prepare to look more closely at a company's stock, let's answer a few questions to make sure we've grasped the ideas in the lesson thus far. Let's continue our conversation about a company's stock. Now that conversation could be simple, except what we often find is that companies offer different types of stock that give shareholders different ownership rights. Some of this stuff can be complicated, so I thought I'd enlist the help of an important person in the champaign business scene to share his expertise on the matter. First Busey Corporation is a banking and wealth management company headquartered in Champaign, Illinois. I'll be meeting with Chief Financial Officer of the company Robin Elliott, but I won't be meeting him at their headquarters. When you're meeting with a CFO, you'd better be ready to eat, and that's just what I'm doing as I share a power lunch with Robin at a great Champagne restaurant called Escobar's. [MUSIC] Robin, so first I'd like to see if you could just tell us a little bit about Busey and maybe, you're Chief Financial Officer, maybe about what your role entails as CFO. >> Right so Busey's an almost $4 billion financial institution. We have banking, wealth management, just like you would see in the other bank we have ATMs, branches, that kind of thing. So, we're a basic bank we're a little bit unique in that our wealth management practice is a lot bigger than most banks of our size, so that gives us a lot of extra flexibility and a little bit more product to offer our customers that some banks don't have. My role as CFO in the organization, it's unique to be a CFO at a bank because when your product is finance and your area of focus is finance, that means you're kind of area of focus is all over the organization. So I don't get to step out of the production cycle because our production cycle's finance. >> Okay. >> So but under my direct purview we have human resources and facilities, things like that, but primarily management of balance sheet. I get the real privilege of making sure that we're looking forward, 4, 12, 1 year, 2 years, out in advance, we're planning utilisation of resources, our people, our expenses, our capital and making sure we're using those in the best way for our shareholders possible. That's good to hear, because it sounds like I have the right person at the table because I have some questions I wanted to ask you about the balance sheet, by chance. So I happened to bring a balance sheet with me for Busey, and what I thought I'd do is just ask you a couple of questions specifically about the different types of stock that show up on the balance sheet for Busey. >> Great. >> And. Just to start, common stock, can you just describe what common stock is for you guys? >> Right, common stock for us and for most companies, we're a publicly traded company. You can buy us at any point in the day that you want to buy us and you can sell us at any point in the day you want to sell us. So- >> You don't want to hear about that. [LAUGH] >> Right, we prefer buyers. But our common stock is our stock that's traded, it's what you think of are owners Whenever you think of ownership, they vote on management or management policies, they have privileges that the other ownership types don't have. They also have the highest level of risk in the company meaning if the company were under duress they would be the last ones to get any money out of company as well. So they have the most voting rights but the less liquidity rights in an event that we have to do something bad with the company. >> Okay. I just wanted to clarify something so, when I look on the balance sheet I see common stock, I see a number, there's another line item, just below it called surplus, are those related? >> Surplus is the banking industry's equivalent of additional paid in capital. And so the common stock is evaluated is a par value, and par value, don't want to get into it too far in the weeds, but it's got its roots well back when everything was done in paper and there was no electronic sheet describe some par value to the paper and is normally a de minimis amount. In our case you'll see it's not even .01 cent it's a tenth of one cent. So the surplus or additional paid in capital however you use them interchangeably, is the amount of money people pay us in over that par value. >> Okay. So really when we think about common stock, we should be thinking about those combined. >> Correct. That and retained earning would be, and treasury stock as well, would be the true book value of our common stock. >> Okay. Well, how does this common stock, then, I see another item called series C preferred stock. What's the difference between the preferred stock and the common stock? >> A preferred stock is what it says, it's got a preference built in to the ownership mechanism. Generally, preferred stock has less voting rights than common stock, but they also have a higher liquidity preference. So where as we talked about common stock gets the last one out of the party if something goes bad, preferred stock is the next to the last one out. So they're going to get their money back before common stock does. And generally in our case, it's true, but generally it's true as well, preferred stock you're entitled to some contractual dividend before a common stock can get any money as well. And in the case of this series C preferred stock, that dividend is a contractual amount we have with those shareholders of that preferred stock. They get that money and not until they get that money can common stock get any of their money. >> And can you just help us understand what treasury stock is? >> Sure. >> And why you use it. >> Yea, so treasury stock is essentially stock you've bought back from the marketplace. Now that could be a private market or a public market, you've repurchased it, but you haven't retired it and taken it out of circulation. So we actually can reissue those treasury stock shares, if we choose. And so, whenever we're looking at our resources, a couple of our resources are our liquidity, our cash. How much cash do we have, and how much capital? And if you study some of the great investors they'll talk about allocating their resources, Warren Buffett all these other types. Well, one thing we can do, we can issue dividends and give our common stock holders more money back. We can buy companies, we can build branches, we can hire more people, or we can buy our own stock back. And so whenever we've made a decision to use some of our capital to buy out stock back that goes in the treasury stock and effectively reduces stockholder's equity. >> Okay and what's behind that decision to kind of go and purchase your own stock? >> Right in theory you should not have a better use for your capital than to purchase your own stock back, that would be the only reason you'd have it. So the economic environment's not very good, so you're not going to hire more, you're not going to build more branches. Maybe the industry's not very good or the industry's really too good and it's too expensive and so you decide you're not going to buy any companies or any major assets. And usually those things may cause your stock to be undervalued in your own analysis. So under that analysis you would say, okay, my next best use for my capital that I'm bringing in is to buy my stock back, rather than give it back to the shareholders or do all these other things we talked about, acquiring companies, building branches, and hiring people. >> Okay, well thanks for meeting me for lunch. >> No problem. >> And more importantly thanks for shedding some light on these different types of stock. >> Yeah, I'm a finance guy in banking so I can always talk about the balance sheet. >> Thanks Robert. A big thanks to Mr. Elliott for sharing his time and expertise. I want to follow up on an idea that didn't come up over lunch. The line item common stock should reflect the amount the shareholders contributed to the company. But often the total contribution is split between the line item labeled common stock and a separate line item labeled additional paid-in capital or APIC for short. There's a complicated history behind the practice of splitting the contributions between the two accounts. But just know the sum of the accounts represents the contributions the company received. Now having discussed owner's contribution as part of a company's net worth, let's turn to the second part of net worth. This part is easy to understand, in the equity section of the balance sheet, you see the line item, retained earnings. In the line item's label, literally describes what the line item represents. It's the portion of company's earnings or net income that is retained by the company rather than being distributed to the company's owners. In an earlier lesson we described net income as the difference between resources the company earns and the resources it disburses during a period. Well when a period ends, the company must dump net income somewhere as it prepares to measure net income for a new period. Retained earnings is where net income is dumped at the end of each period, and the accumulation of net income will over the life of the company is the second part of the company's net worth. Now, the amount of retained earnings can also decrease for at least two reasons, first, if net income being dumped into retained earnings increases retained earnings, then what happens if a company suffers a net loss during the period? You got it, the net loss gets dumped into retained into retained earnings and decreases its balance. Second, the company can pay cash dividends to its owners, which represents a distribution of retained earnings. In essence, dividends return to owners a portion of their claim on the company's net worth. Well, that ends our lesson on equity. In our next lesson we'll revisit what we've learned about the balance sheet as we continue to understand financial statements. Until then, be well. [MUSIC]
