Capital is at Ion - Final

8/3/2019 Capital is at Ion - Final

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Concept and Meaning Capital plays an important role in any business.

Capitalisation refers to the long term indebtedness and includes boththe ownership capital and the borrowed capital.

Capital and Capitalisation are two different terms. The term 'capitalisation' 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 orresources of a company. It thus represents total wealth of the company.

It should be distinguished from share capital which refers only to thepaid up value of the shares issued by the company and definitelyexcludes bonds, debentures, loans and other form of borrowings.


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Concept and Meaning Capitalisation means the total par value of all the securities, i.e. shares

and debentures issued by a company and reserves, surplus and value ofall 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 andsecurities still not redeemed and the value of long term loans. Capitalisation is thus the sum total of all long term funds available to

the firm along with the free reserves. According to E.T. Lincoln capitalisation is "a word ordinarily used to

refer to the sum of outstanding stocks and funded obligations which

may represent fictitious values". According to Gerstenbug, capitalisation is that which "comprises of acompany's ownership capital which includes capital stock and surplusin whatever form it may appear and borrowed capital which consists ofbonds or similar evidences of long-term debt".


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Over Capitalisation

A company is said to be over capitalised when its earnings arenot sufficient to yield a fair return on the amount of shares ordebentures.

In other words, when a company is not in a position to paydividends and interests on its shares and debentures at fairrates, it is said to be over capitalised.

According to Hoagland, "whenever the aggregate of the parvalues of stocks or bonds outstanding exceeded the true valueof the fixed assets the corporation is said to be over-capitalised.

According to Gestenberg, "a corporation is over-capitalisedwhen its earnings are not large enough to yield a fair return on

the amount of stocks and bonds that have been issued or whenthe amount of securities outstanding exceeds the current valueof assets.


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Over-capitalisation is not synonymous with excess capital.Excess of capital may be one of the reasons for over-capitalisation.

A company is over capitalised only because of its capital and

funds not being effectively and profitably deployed with theresult that there is a fall in the earning capacity of thecompany and in the rate of dividend to be paid to itsshareholders as well as a fall in the market value of itsshares.


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Causes of Over-capitalisation1. Floating of excess capital

2. Purchasing property at an inflated prices

3. Inflationary conditions

4. Promotion during inflation

5. High cost of promotion

6. Borrowings at a higher than normal rate

7. Incorrect capitalisation rate applied

8. High rates of taxation

9. Liberal dividend policy10. Wrong estimation of future earnings

11. Inadequate depreciation


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Effects of Over-capitalisation1. Loss of goodwill2. Difficulty in obtaining capital

3. Window dressing of accounts4. Decline in efficiency & Liquidity5. Low rate of dividend

6. Fall in the Market value of shares7. Small value of collateral

8. Speculative gambling9. Cuts in wages10. Misapplication of society's resources

11. Gambling in shares12. Setback to industry13. Reduction in quality of product

14. Competition


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Remedies of Over-capitalisation

Reduction of funded debts

Reduction of interest on debentures andloans

Reduction of preference shares

Reduction of face value of the shares

Reduction in the number of equity shares


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UNDER CAPITALISATION Under-capitalisation is just reverse of over-capitalisation.

The state of under-capitalisation is where the value of assets aremuch 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-capitalisation, under-capitalisation is associated with an effectiveutilisation of investments, an exceptionally high rate of dividend andenhanced prices of shares.

In other words, the capital of the company is less in proportion to itstotal requirements under the state of under-capitalisation.

Under-capitalisation is a condition where the real value of thecompany is more than its book value.


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In the words of Gerstenberg, "A corporation may be under-capitalisedwhen the rate of profits it is making on the total capital is exceptionallyhigh in relation to the return enjoyed by similarly situated companies inthe same industry or when it has too little capital with which to conductits business.

The assets bring profits but it would appear to be much larger thanwarranted by book figures of the capital. In such cases, the dividend willnaturally be high and the market value of shares will be much higher.

Under-capitalisation and inadequacy of capital are regarded as inter-changeable terms but there is a difference between these two terms.

Under-capitalisation does not mean inadequacy of capital. Profits are

high in such companies and a part of the profits are ploughed back in thebusiness directly or indirectly. The value of assets are shown at lowerprice than their real value. It means that there are secret reserves inunder-capitalised companies.


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Causes of Under-capitalisation Under estimation of capital requirements

Under estimation of future earnings

Promotion during deflation

Narrow dividend policy Desire of control

Excessive depreciation provided

Maintenance of high efficiency

Secret reserves Difficulty in procurement of capital


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Effects of Under-capitalisation Limited marketability of shares

Cut-throat competition

Industrial unrest

Dissatisfaction of customers Government control

Inadequacy of capital

Secret reserves and window dressing of accounts

High taxes Manipulation of share values


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Remedies of under-capitalisation Splitting up of shares

Increasing the number of shares

Increase in the par value of shares

Issue of Bonus shares

Fresh issue of shares

Capital is at Ion - Final

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