Concept and Meaning

Capital plays an important role in any business. Capitalisation refers to the long term indebtedness and includes both

the 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 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.

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 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. 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 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 capitalised 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 capitalised. 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 overcapitalised. According to Gestenberg, "a corporation is over-capitalised when its earnings are 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-capitalisation is not synonymous with excess capital. Excess of capital may be one of the reasons for overcapitalisation. A company is over capitalised 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 Overcapitalisation
1. 2. 3. 4. 5.

6.
7. 8. 9.

10.
11.

Floating of excess capital Purchasing property at an inflated prices Inflationary conditions Promotion during inflation High cost of promotion Borrowings at a higher than normal rate Incorrect capitalisation rate applied High rates of taxation Liberal dividend policy Wrong estimation of future earnings Inadequate depreciation

Effects of Overcapitalisation
1. 2. 3. 4. 5. 6.

7.
8. 9. 10. 11.

12.
13. 14.

Loss of goodwill Difficulty in obtaining capital Window dressing of accounts Decline in efficiency & Liquidity Low rate of dividend Fall in the Market value of shares Small value of collateral Speculative gambling Cuts in wages Misapplication of society's resources Gambling in shares Setback to industry Reduction in quality of product Competition

Remedies of Over-capitalisation

Reduction of funded debts Reduction of interest on debentures and

loans Reduction of preference shares Reduction of face value of the shares Reduction in the number of equity shares

UNDER CAPITALISATION
Under-capitalisation is just reverse of over-capitalisation.
The state of under-capitalisation 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 overcapitalisation, under-capitalisation is associated with an effective utilisation 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-capitalisation.

Under-capitalisation is a condition where the real value of the

company is more than its book value.

In the words of Gerstenberg, "A corporation may be under-capitalised 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. 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-capitalisation and inadequacy of capital are regarded as interchangeable 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 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-capitalised companies.

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

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

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