Small businesses in need of capital for expansion via acquisition may choose to incorporate and sell stock in the company to finance the growth. Despite common stock and retained earnings both appearing in the shareholders' equity section of a balance sheet, sales of shares of stock primarily affect retained earnings when dividends are issued to the shareholders.
Common Stock Issue
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Issuing common stock generates cash for a business, and this inflow is recorded as a debit in the cash account and a credit in the common stock account. The proceeds from the stock sale become part of the total shareholders' equity for the corporation but do not affect retained earnings.
Retained Earnings
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The retained earnings account contains the accumulated net income of the business. When a dividend is issued to shareholders of common stock, a debit to retained earnings occurs to finance the payment. Since dividends are typically issued when profits are high, retained earnings and stockholders' equity may still increase during the reporting period due to net income offsetting the dividend payment.
