Question

Discuss the importance of treasury stock. Why do we need them? Explain.

Answer 1

Treasury stocks are investment by the companies in its own shares. They are purchased by company in the open market as part of its investment whenever it has excess cash. Treasury shares are debited whenever purchase is made. Treasury shares are shown in stockholders equity by way of deduction since treasury shares are debit balance.

Company engages in purchase and re-sell of treasury stocks whenever they have excess cash and they want to utilise the same to improve return on shareholders’ equity. Purchase of treasury stock is one of the best alternatives available for a company to use its excess cash. A company having excess cash tries to use it efficiently to improve return on investment. When no alternatives are available for investments, company can pursue purchasing its own shares to improve return on investment to shareholders.

The earnings per share will improve due to treasury shares purchase. The reason being the number of outstanding shares will decrease and earning per share (EPS) will increase due to lower denominator. Increased earning per share will lead to higher market share price. Investors usually cheer buyback arrangements by companies.