Bonus Issue Calculation

A bonus issue, also referred to as a scrip issue, is a financial strategy that companies use to distribute additional shares to their existing shareholders. This method involves issuing shares for free, based on the proportion of shares that a shareholder already owns in the company. The bonus shares are typically issued in a fixed ratio to the number of shares that the shareholder currently holds. For example, a company may announce a bonus issue of one-for-six, which means that for every six shares an investor owns, they will receive an additional share for free. Bonus issues are generally seen as a sign of a company's financial health and can be a way to reward shareholders without requiring any additional capital from them.

The primary motivation behind a bonus issue is often to increase the liquidity of a company's shares, making them more accessible and affordable to a larger number of investors. By issuing additional shares, the company can reduce the market price of its existing shares while keeping the total market capitalization the same. In essence, bonus issues can be viewed as a way to adjust the share price downwards without altering the overall value of the company. This strategy can make the company's shares more attractive to smaller investors, who may otherwise find the shares too expensive to purchase.

A bonus issue does not require shareholders to pay any money for the new shares they receive. Instead, the company issues the bonus shares by converting a portion of its retained earnings or reserves into share capital. This is a non-cash transaction that does not affect the overall financial position of the company, but it does result in a dilution of the value of each individual share. While shareholders receive additional shares, the value of each share is reduced proportionally, so the total value of their holdings remains the same, assuming no other changes in the company’s financial performance.

The issuance of bonus shares is also a reflection of the company's ability to generate profits. A company that is doing well financially may choose to issue bonus shares as a way of rewarding shareholders for their continued investment and loyalty. It demonstrates that the company has accumulated sufficient profits or reserves to redistribute to its shareholders in the form of additional equity. This can be an appealing gesture for investors, as it can signal that the company is in a strong financial position and is confident about its future prospects. The decision to issue bonus shares is typically made by the company’s board of directors and is usually subject to approval by the shareholders.

In some cases, bonus issues are used as a strategy to avoid paying dividends in cash. When a company issues bonus shares, shareholders receive additional shares instead of cash dividends. This may be advantageous for the company if it wants to conserve cash for reinvestment or to fund other projects. For shareholders, while they are not receiving cash immediately, the value of their holdings may increase in the long term as a result of the additional shares. This method of compensating shareholders can be particularly attractive during times when cash flow is tight or when the company is focusing on growth initiatives that require significant investment.

One of the benefits of bonus issues is that they do not require shareholders to pay any extra funds for the new shares. This can make the process of acquiring additional shares easier for existing shareholders, particularly those who may not have the financial means to purchase additional shares through the open market. By offering shares for free, companies make it easier for their shareholders to increase their stake in the company without needing to commit more capital. This can be an especially beneficial option for smaller shareholders who may not have the resources to buy more shares on their own.

On the other hand, bonus issues can also have negative implications for shareholders. While the immediate effect of a bonus issue is the receipt of additional shares, the value of those shares is diluted by the increase in the total number of shares outstanding. The overall market capitalization of the company remains unchanged, but the individual value of each share decreases. For example, if a shareholder owns 100 shares worth $10 each, they may receive an additional 20 shares through a 1-for-5 bonus issue, increasing their total number of shares to 120. However, the value of each share may fall to around $8.33, so the total value of their holdings remains the same ($1000). In this sense, while shareholders may receive more shares, they do not gain any immediate financial benefit from the bonus issue.

Additionally, the issuance of bonus shares can be seen as a sign that the company has no immediate investment opportunities in which to deploy its retained earnings. If a company consistently issues bonus shares instead of paying cash dividends or reinvesting the earnings into high-growth projects, it may raise questions about the company’s future growth prospects. Some investors may interpret the bonus issue as a sign that the company is struggling to find productive ways to use its capital, which could lead to concerns about its long-term profitability and sustainability.

From the perspective of the stock market, bonus issues can also affect the perception of the company’s stock price. While the immediate effect of a bonus issue is typically a drop in the price of the shares, it can also create an impression of growth and financial strength. In the short term, the stock price may decrease as the market adjusts to the increase in the number of shares. However, in the long term, the additional liquidity created by the bonus issue could help the stock become more attractive to a broader base of investors, potentially increasing demand for the shares and leading to higher prices in the future.

Bonus issues can also serve as a signal to the market that the company is in a strong position and expects continued profitability. Investors often view bonus issues as a positive signal, as they indicate that the company has sufficient profits or reserves to distribute additional shares to its shareholders. This can build investor confidence, potentially leading to higher stock prices in the future. However, the initial price drop immediately following the bonus issue can lead to short-term volatility, which may be unsettling for some investors.

Learn how to calculate bonus issue of shares with the following example:

The following information relates to CCK Ltd:
Capital and reserves:
200,000 $1 ordinary shares $200,000
Share premium $30,000
General reserve $20,000
At the end of the year, the company declared a 1 for 4 bonus issue to capitalize all the reserves.

Then,
Free issue = 200,000 * 1/4 = 50,000 shares
After the bonus issue, the share capital is: 200,000 + 50,000 = $250,000
Share premium = $0
General reserve = $0
Note: The bonus shares of $50,000 are financed out of the company reserves, i.e., $30,000 from share premium and $20,00 from general reserve.