Companies may initially finance their asset purchases and operations with both owners' contributed capital, or paid-in capital, and borrowed funds. The more the amount of paid-in capital compared to that of the borrowed funds, the less likely any asset and operation losses are likely to affect a company's ability to repay funds from borrowing. Conversely, the amount of potential losses may exceed a relatively low level of paid-in capital and result in negative equity, a loss in borrowed funds.
Unless companies issue more shares to raise capital, paid-in capital remains at its outstanding amount. But companies can accumulate more capital through retained earnings, which is another main capital account. The amount of retained earnings changes over time with the rise and fall in a company's net income. The balance in retained earnings at the end of an accounting period is the sum of the beginning balance and any earnings or losses during the period, and can be positive or negative.
Losses from operations are subtracted from existing retained earnings. When total accumulated losses exceed total accumulated earnings, the capital account of retained earnings becomes negative. A negative capital account hinders a company's ability to protect itself against any future uncertainties, and any existing negativity in the capital account results in unmet liabilities by the same amount. Unless a company can restore its negative capital account to positive, it may have to declare insolvency to creditors providing the borrowing.
Companies periodically reevaluate certain assets based on their current market value, and any decline in an asset's market value results in a mark-down of the asset's value as stated on the balance sheet. Any asset losses, first, reduce the capital account of retained earnings on top of any reductions by net operational losses when total operational expenses exceed total sales. After retained earnings have been reduced to zero, any further asset losses are absorbed by owners' paid-in capital. While the account of paid-in capital itself doesn't turn negative, the total shareholders' equity section of the balance sheet can become negative if the accumulated negative amount in retained earnings is greater than the amount of paid-in capital.