Capital and Capitalization

Capital plays an important role in any business.

Capitalization refers to the long term indebtedness
and includes both the ownership capital and the
borrowed capital. Capital and Capitalization are two
different terms. The term 'capitalization' is used
only in relation to companies and not in respect of
partnership firms or sole proprietorships. It is
distinguished from capital which represents total
investment or resources of a company. It thus
represents total wealth of the company. It should
be distinguished from share capital which refers
only to the paid up value of the shares issued by
the company and definitely excludes bonds,
debentures, loans and other form of borrowings.
 Capitalization
Capitalization means the total par value of
all the securities, i.e. shares and
debentures issued by a company and
reserves, surplus and value of all other
long term obligations. The term thus
includes the value of ordinary and
preference shares, the value of all surplus
– earned and capital, the value of bonds
and securities still not redeemed and the
value of long term loans. Capitalization is
thus the sum total of all long term funds
available to the firm along with the free
reserves.
 Definitions
According to E.T. Lincoln
capitalization is "a word ordinarily
used to refer to the sum of
outstanding stocks and funded
obligations which may represent
fictitious values".
According to Gerstenbug,
capitalization is that which
"comprises of a company's
ownership capital which includes
capital stock and surplus in whatever
form it may appear and borrowed
capital which consists of bonds or
similar evidences of long-term debt".
 OVER CAPITALISATION
A company is said to be over capitalized
when its earnings are not sufficient to
yield a fair return on the amount of shares
or debentures. IN other words, when a
company is not in a position to pay
dividends and interests on its shares and
debentures at fair rates, it is said to be
over capitalized. It means that an over-
capitalized company is unable to pay a fair
return on its investment.
 Definitions
According to Hoagland, "whenever the aggregate
of the par values of stocks or bonds outstanding
exceeded the true value of the fixed assets the
corporation is said to be over-capitalized".
According to Gerstenberg, "a corporation is over-
capitalized when its earnings are not large
enough to yield a fair return on the amount of
stocks and not large enough to yield a fair return
on the amount of stocks and bonds that have
been issued or when the amount of securities
outstanding exceeds the current value of assets".
Over-capitalization is not synonymous with
excess capital. Excess of capital may be
one of the reasons for over-capitalization.
A company is over capitalized only
because of its capital and funds not being
effectively and profitably deployed with
the result that there is a fall in the earning
capacity of the company and in the rate of
dividend to be paid to its shareholders as
well as a fall in the market value of its
shares.
 Causes of Over-capitalization

1. Floating of excess capital.

2. Purchasing property at an inflated price.
3. Inflationary conditions.
4. High cost of promotion.
5. Borrowings at a higher than normal rate.
6. Purchase of assets in the boom period.
7. Incorrect capitalization rate applied.
8. Insufficient provision for depreciation.
9. High rates of taxation.
10. Liberal dividend policy.
11. Wrong estimation of future earnings.
12. Low production
 Remedial measures to correct
Over-capitalization
1. Reduction of funded debts.
2. Reduction of interest on debentures and
loans.
3. Reduction of preference shares.
4. Reduction of face value of the shares.
5. Reduction in the number of equity
shares.
6. Ploughing back of profits.
 Effects of Over-capitalization
1. Loss of goodwill.
2. Difficulty in obtaining
capital.
3. Window dressing of
accounts.
4. Decline in efficiency.
5. Liquidation.
6. Loss of Market.
7. Low rate of dividend.
8. Fall in the Market value of
shares.
9.Loss on re-organization.
10. Small value of collateral.
11. Speculative gambling.
12. Reduction in quality.
13. Cuts in wages.
14. Competition.
15. Misapplication of society's
resources.
16. Gambling in shares.
17. Setback to industry.
 UNDER CAPITALISATION

Under-capitalization is just reverse of over-

capitalization. The state of under-capitalization is
where the value of assets are much more than it
appears in the books of the company. In well
established companies, there is a large
appreciation in assets, but such appreciation is
now shown in the books. As against over-
capitalization, under-capitalization is associated
with an effective utilization of investments, an
exceptionally high rate of dividend and enhanced
prices of shares. In other words, the capital of
the company is less in proportion to its total
requirements under the state of under-
capitalization.
 Definitions
In the words of Gerstenberg, "A
corporation may be under-capitalized
when the rate of profits, it is making
on the total capital is exceptionally
high in relation to the return enjoyed
by similarly situated companies in
the same industry or when it has too
little capital with which to conduct its
business".
Under-capitalization is a condition where the real value of
the company is more than its book value. The assets bring
profits but it would appear to be much larger than
warranted by book figures of the capital. In such cases, the
dividend will naturally be high and the market value of
shares will be much higher. Under-capitalization and
inadequacy of capital are regarded as inter-changeable
terms but there is a difference between these two terms.
Under-capitalization does not mean inadequacy of capital.
Profits are high in such companies and a part of the profits
are ploughed back in the business directly or indirectly. The
value of assets are shown at lower price than their real
value. It means that there are secret reserves in under-
capitalized companies.
 Causes of Under-capitalization
1. Under estimation of capital requirements.
2. Under estimation of future earnings.
3. Promotion during deflation.
4. Narrow dividend policy.
5. Desire of control.
6. Excessive depreciation provided.
7. Maintenance of high efficiency.
8. Secret reserves.
9. Difficulty in procurement of capital.
 Remedies of under-capitalization
1. Splitting up of shares.
2. Increasing the number of shares.
3. Increase in the par value of shares.
4. Issue of Bonus shares.
5. Fresh issue of shares.
 Effects of Under-capitalization.

1. Limited marketability of shares.

2. Cut-throat competition.
3. Industrial unrest.
4. Dissatisfaction of customers.
5. Government control.
6. Inadequacy of capital.
7. Secret reserves and window dressing of
accounts.
8. High taxes.
9. Manipulation of share values.