The document discusses capitalization and different types of capitalization situations for companies. It defines capitalization broadly as the total amount invested in a business and more narrowly as determining long-term funding needs. Over-capitalization occurs when a company's capitalization exceeds its average income, preventing a fair return. Under-capitalization is the opposite, with high profits generated from efficient asset use. The document outlines causes, effects, and remedies for over-capitalization and under-capitalization situations.
2. Meaning/ Definition
General sense- It is related to total amount invested in business.
Broad sense- It means forecasting the need of funds for company, their
sources and the proportion of such sources.
Narrow sense- This refers to the process by which a firm determines the
quantum of long term requirement of funds.
Modern sense –The narrow interpretation of term capitalization is widely
accepted since it is very specific in the meaning. However, in the modern
concept, not only the long term funds but also the short term funds are
included in capitalization.
3. Definition
“Capitalization means that amount of capital
which is represented by the total shares held by
shareholders and the issued debentures and
bonds.”
According to the modern concept, not only the
long-term capital but also the short term
capital is included in capitalization.
5. Over-capitalization
When the amount of capitalization of a
company is greater as compared to its
average income.
When the firm unable to get a fair return on
its capital.
When the firm is unable to distribute a fair
dividend to its shareholders.
It is said to be over-capitalized
6. Over-capitalization (Cont’d)
“When a company has consistently been unable to
earn fair return on the amount of shares and
debentures that have been issued than it is said to
be Over-capitalized.”
So when a company is unable to earn sufficient profits
on its capital employed & the real value of its total
assets is less than its book value
Real Value of Total Assets < Book
Value ofTotal Assets
7. Values of shares
Par Value of
shares
• It means face value of the shares which is mentioned in MOA
Market
Value of
shares
• It means that value of shares which is mentioned in the stock
exchange.
• It is affected by internal & external factors
Book Value
of the
shares
• It is the price which we get by dividing the sum of share
capital & reserves and surplus with the number of shares
issued
Real Value
of shares
• It is calculated by dividing the capitalized value of assets
with the number of shares issued
• Capitalized value = Avg. Annual income / Capitalization rate
• Real Value of shares= Capitalized value / number of shares
issued
8. The balance sheet of XYZ ltd as on 31-12-2010 is given below. If Avg.
annual earnings of company are Rs 18,000 & if required rate of
return is 12 %. Calculate Par value, Book Value, market value & real
value.
Example
Liabilities Amount Assets Amount
Share Capital(Paid Up) Sundry Assets 2,70,000
15,000 shares @ 10 Rs
Each
1,50,000
Reserve & Surplus 75,000
Sundry Liabilities 45,000
Total 2,70,000 Total 2,70,000
9. Solution
Par Value of shares = Rs.10 per share
Book Value = 1,50,000 + 75,000
15,000
= Rs 15 per share
Market Value = Opening Price + Closing Price
2
Real Value :--
Capitalized value = 18,000 = 1,50,000
12%
Real Value = 1,50,000
15000
= Rs. 10 per share
10. Causes of Over-Capitalization
Over-Issue of capital
Over-estimations of earnings at the time of promotion
Expansion or promotion of the company during boom period
Liberal Dividend Policy
Shortage of capital
High promotion expenses
12. Consequences of Over-
Capitalization
Effects on Company
Adverse impact on goodwill of company
Difficulty is raising additional funds
Decline in efficiency of the company
Difficulty in the payment of interest
Manipulation of accounts to show inflated profits
13. Consequences of Over-
Capitalization
Effects on Shareholders
Due to lower earnings shareholders get
lower dividend
Adverse impact on market value of shares.
Unacceptable as collateral security
14. Remedies for Over-
Capitalization
Reduction in long-term debt
Reduction in the rate of
Interest on debentures
Redemption of high dividend
preferred stock
Ploughing back of profits
15. Under-Capitalization
It is the situation when a company is
continuously earning abnormally high profits on
its capital employed.
In this Market value of the share is higher than its
BookValue
It signifies that the assets of the company are
being utilized more efficiently
It is the situation when the average income of
company is greater as compared to the amount
of capitalization & such company declares
dividend at a higher rate.
16. Causes of Under-Capitalization
Under-
estimation of
Earnings
Promotion of
company with
deflated assets
Conservative
dividend policy
Under
estimations of
capital
requirements
Low promotion
expenses
17. Effects of Under-Capitalization
Effects on the Company
• It helps in increasing the competition in the
market.
• Firms have to pay higher taxes on higher incomes.
• Due to high profits the workers can demand for
more wages and bonus.
• It leads to the possibility of government
interference due to high profits
18. Effects of Under-Capitalization
• They can earn high rate of
dividend
• It also increases Market value
of share which leads to
speculation in the market
• Due to high goodwill the
shareholders can easily raise
loan on the security of shares.
Effects on
Shareholders
19. Effects of Under-Capitalization
on society
It encourages
new
entrepreneurs
to establish
new businesses
Consumers can
get better
quality of
products at
fair prices
It generates
employment in
society
It creates
capital
formation in
the country
