Every company rewards its shareholders in different ways; some might issue Dividends, and some might give extra shares.
Bonus issues and Share splits are two such methods of rewarding shareholders.
Bonus and share split are two well-known business practices performed by listed companies to increase the number of shares sold. Investors are often confused between the two.
Let us understand the difference between the bonus issue and a stock split and why companies issue bonus shares and do a stock split and how they affect shareholders.
A Bonus issue is an offer given to the existing shareholders of the company where a subscription to additional shares is offered.
The company may offer to issue bonus shares instead of increasing the dividend payout.
For example, a company may offer to issue a bonus of 1 share for every 5 shares held in the company.
Companies issue bonus shares to encourage retail participation and increase their equity capital base. When a company’s share price is high, it becomes difficult for new investors to buy shares of that particular company. An increase in the number of shares lowers the price per share.
Cash flow is not involved in the Bonus issue and it does not increase the total assets of the company as no cash flow is involved but only the share capital.
The issue of Bonus shares increases the number of outstanding shares of the company as additional shares are offered to the shareholders.
For example, if a shareholder is holding 50 shares in a company and the total number of outstanding shares is 500.
Now, the company issues a bonus of 1 share for every 5 shares held then,
Bonus shares to be issued to a shareholder holding 50 shares will be 10 shares (50*1/5) and the total number of bonus shares to be issued by the company will be 100 shares (500*1/5).
The total number of shares after the Bonus issue will be 600 shares (500 shares + 100 bonus shares).
Some merits and demerits of issuing bonus shares are as follows:
There are several pros of a Bonus issue and they are as follows:
There is also a flip side to the Bonus issue. The cons of issuing bonus shares are as follows:
From an investor’s point of view:
From a company perspective:
There are generally two types of bonus shares a company may issue, fully paid Bonus shares and Partly paid bonus shares. Fully paid bonus shares and partly paid bonus shares are explained in brief in the below table.
Serial No. | Basis | Fully Paid Bonus Shares. | Partly Paid Bonus shares. |
1. | Application of Bonus | When bonus shares are issued to the shareholders at no additional cost, that means; the company is not charging any amount for additional shares called Fully paid Bonus shares. | When a Bonus is applied to convert the partly paid shares into fully paid shares, it is called Partly Paid Bonus Shares. |
2. | Sources of issue | The following are some sources through which the fully paid Bonus shares can be issued:
Profit and loss Account, investment allowance reserve, capital redemption reserve, etc. |
The following are some sources through which the partly paid Bonus shares can be issued:
Investment allowance reserve, General reserve, development rebate reserve, etc.
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The Face Value remains the same in the bonus issue. The additional shares issued carry the same face value as the already outstanding shares.
A bonus issue is made when the company is out of cash; its motive is not to increase or decrease the face value of the shares.
The face value of each share remains the same, but the number of shares increases as a result of additional shares issued and thus increases the share capital of the company.
For Example, if a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a bonus issue of 1 share for every 5 shares held in the company.
The total number of shares post the bonus issue will increase to 1200 shares (1000 shares + 1000*1/5 shares), but the face value of each share will remain the same, i.e., Rs. 100 per share.
An investor gets additional shares at no cost to pocket.
The share-holding of the investor increases and as a result has chances to get more dividends in the future due to an increase in the number of shares held.
For Example, suppose an investor is holding 100 shares of a company and the company issues bonus shares in a ratio of 1 share for every 4 shares held in the company.
In that case, the number of shares held by the investor will increase to 125 (100 shares + 100 shares * 1/4), and if the company issues a dividend of Rs.5 per share in future, then the investor will get a dividend of Rs. 625 (125 shares * Rs. 5 per share) instead of Rs. 500 (100 shares * Rs. 5 per share).
When the company issues bonus shares, the share capital increases as additional shares are issued by the company, and the reserves of the company decrease as the bonus issue is made out of the reserves of the company.
(Profit and loss Account, investment allowance reserve, capital redemption reserve, General reserve, development rebate reserve).
For Example, if a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a bonus issue of 1 share for every 5 shares held in the company.
The total number of shares post the bonus issue will increase to 1200 shares (1000 shares + 1000*1/5 shares), but the face value of each share will remain the same, i.e., Rs. 100 per share.
Thus, we can see that the share capital of the company has increased from Rs. 100000 (1000 shares * Rs. 100) to Rs. 120000 (1200 shares * Rs. 100).
Such an issue is made out of the reserves of the company due to which the company’s reserve decreases. The reserves of the company decreased by Rs. 20000. (200 Bonus shares * face value of Rs. 100 per share), which on the other hand, increased the share capital of the company due to the bonus issue.
The Face value of the shares remains the same. The Bonus issue is an effective way of restructuring the capital structure of the company; as it results in an increase in the share capital and a decrease in the reserves of the company. Thus, the bonus issue has no effect on the net worth of the company.
A stock split is when the number of shares gets multiplied. As the name suggests, there is a “Split” in the number of shares held.
In case of a split of shares, no new shares are issued by the company. If a company issues a share split in the 1:3 ratio, then the total number of outstanding shares gets multiplied by 3 which means that 1 share of the company becomes 3 shares after the share split.
A share of the company is broken into parts in a share split, the face value gets reduced and the number of shares increases while the share capital remains the same as there neither is an issue of new shares nor the cashflow change.
For example, if a company has 1000 shares outstanding having a face value of Rs.10 per share and an investor is holding 100 shares out of those outstanding shares.
The company issues a stock split in the ratio of 1:2 then,
The total number of shares outstanding in the company will be 2000 (1000 shares * 2) and the shares held by the investor will be 200 (100 shares * 2) after the stock split.
The face value of the company’s share will get reduced to Rs. 5 each (10/2) resulting in no change in the share capital of the company.
Reverse stock, as the name suggests is an action opposite to the stock split, which means that in the case of a reverse stock split, the shares of the company are consolidated, and the total number of shares gets reduced.
A reverse stock split divides the number of shares by the ratio the company determines. Ratios could be 1 for 4 or 1 for 5, or any other ratio.
In a reverse stock split, more than 1 share gets consolidated and makes a single stock which reduces the total number of shares outstanding, while the face value of the company’s share increases which results in no change in the share capital of the company.
For example, if a company has 1000 shares outstanding having a face value of Rs.10 per share and an investor is holding 100 shares out of those outstanding shares. The company issues a reverse stock split in the ratio of 1:2.
The total number of shares outstanding in the company will be 500 (1000 shares / 2), and the shares held by the investor will be 50 (100 shares / 2) after the stock split.
The face value of the company’s share will get reduced to Rs. 20 each (10 * 2), resulting in no change in the share capital of the company.
Some merits and demerits of the stock split are as follows:
There are several benefits of splitting stocks, and they are as follows:
There is also a flip side to splitting stocks. The disadvantages of a stock split are as follows:
Let us tell you how a stock split differs from a reverse stock split with the help of a comparison chart.
Serial No. | Parameter. | Stock split. | Reverse stock split. |
1. | The number of shares. | The number of shares increases in case of a stock split. | The number of shares decreases in case of a reverse stock split. |
2. | Face Value | The face value per share in the case of a stock split decreases. | The face value per share in the case of reverse stock split increases. |
3. | Example | Splitting 100 shares of a company into 200 shares. (1:2) | Consolidating 100 shares of a company into 50 shares. (1 for 2) |
The Face Value decreases in the case of a stock split and increases in the case of a reverse stock split.
No additional shares are issued by the company, but the issued shares are split into multiple shares.
Thus, face value increases proportionately. A stock split is done when the company wants its shares to be traded in the market more often, thus face value decreases.
The face value of each share decreases, but the number of shares increases proportionately; thus the share capital remains the same.
An investor’s shares get multiplied in case of a stock split and get divided in case of a reverse stock split.
For Example:
1) If an investor is holding 100 shares of a company having a face value of Rs.10 each and the company makes a stock split in a ratio of 1: 4, the number of shares held by the investor will increase to 400 (100 shares * 4) with a face value of Rs. 2.5 (Rs. 10 / 4).
2) If an investor is holding 100 shares of a company having a face value of Rs.10 each and the company makes a reverse stock split in a ratio of 1: 4, the number of shares held by the investor will decrease to 25 (100 shares / 4) with a face value of Rs. 40 (Rs. 10 * 4).
When the company makes a stock split or a reverse stock split, the share capital does not change as the company issues no additional shares and the reserves of the company also remain the same as the stock split does not affect the reserves of the company.
For Example, if a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a stock split in the ratio of 1: 5.
The total number of shares post the stock split will increase to 5000 shares (1000 shares * 5), but the face value of each share will decrease, i.e., Rs. 20 per share (100/5).
Thus, we can see that the share capital of the company remains the same at Rs. 100000. This does not affect the reserves of the company.
There are several aspects in which a bonus issue differs from stock split. To ease your understanding, we have provided an all-encompassing comparison chart between bonus issue and stock split.
Serial No. | Parameters | Bonus issue | Stock Split |
1. | Meaning | A Bonus issue is an offer given to the existing shareholders of the company where a subscription to additional shares is offered | A stock split is when the number of shares gets multiplied. As the name suggests there is a “Split” in the number of shares held |
2. | Effect on the Face Value | The Face Value remains the same in the bonus issue. The additional shares issued carry the same face value as the already outstanding shares. | The Face Value decreases in the case of a stock split and increases in the case of a reverse stock split. |
3. | Effect on Shareholders. | An investor gets additional shares at no cost to pocket. The share-holding of the investor increases and as a result has chances to get more dividends in the future due to an increase in the number of shares held.
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An investor’s shares get multiplied in case of a stock split and get divided in case of a reverse stock split.
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4. | Impact on share capital | When the company issues bonus shares the share capital increases as additional shares are issued by the company. | When the company makes a stock split or a reverse stock split, the share capital does not change as no additional shares are issued by the company. |
5. | Impact on reserves?
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The reserves of the company decrease as the bonus issue are made out of the reserves of the company. (Profit and loss Account, investment allowance reserve, capital redemption reserve, General reserve, development rebate reserve).
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The reserves of the company remain the same as the stock split does not affect the reserves of the company. |
6. | Example. | If a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a bonus issue of 1 share for every 5 shares held in the company. The total number of shares post the bonus issue will increase to 1200 shares (1000 shares + 1000*1/5 shares). | If an investor is holding 100 shares of a company having a face value of Rs.10 each and the company makes a stock split in a ratio of 1: 4, the number of shares held by the investor will increase to 400 (100 shares * 4) with a face value of Rs. 2.5 (Rs. 10 / 4).
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7. | Types | Fully paid Bonus shares and Partly paid bonus shares. | Stock split and Reverse stock split. |
Overall, the number of shares increases in both bonus issues and the stock split. The face value decreases in stock split while the bonus issue has no impact on the face value of the share of the company.
This is the main difference between the bonus issue and the stock split. A bonus issue indicates that the company has extra cash that it can convert to capital.
A stock split is a step toward making expensive stocks available to a larger audience of shareholders in the stock market.
The main purpose of issuing bonus shares is to capitalise on the reserves of the company.
It also increases the liquidity of the company’s shares as the number of shares increases.
Bonus shares are issued to the shareholders instead of issuing dividends to shareholders when the company is facing liquidity issues as no cash flow is required to issue bonus shares.
The companies having excess free reserves and have no other ways for investments generally issue bonus shares.
Also, the companies lack liquidity and shareholders are expecting dividends
The bonus issue reflects the good health of the company thus, considered to be good for an investor.
The bonus issue decreases the price per share but increases the number of shares and as a result, the capital of the company remains the same.
The company decides to make a stock split to boost the liquidity of the company’s shares.
In a stock split, as the shares are multiplied the liquidity increases.
Companies use the reverse stock sector to prevent the price of the company’s share to go very low.
In the reverse stock split, the number of shares decreases which increases the price of the shares.
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