Capital is at Ion

8/2/2019 Capital is at Ion

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Capitalisation

Unit- IV

Section -A

F.M.


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What is Capitalisation?

Capitalisation refers to the amount of capital

employed in a business.

It also refers the process of determining the plan

of financing.

In short Capitalisation includes:

Estimating the total amount of capital to be raised.

Determining the type of securities to be issued.

Determining the proportion of various securities.


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Definition.

Capitalisation comprises of a companys

ownership capital which include capital stock

and surplus and borrowed capital which

consists of Bonds or similar evidences of a

long term debts.


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Need of Capitalisation

It arises not only at the time of incorporation orpromotion of a company but may also arise as a

going concern after promotion and during life

time of a company.

Generally problem Capitalisation arises:

1. At the time of promotion/ incorporation of a

company.2. At the time of expansion of existing company.

3. At the time of mergers.

4. At the time of reorganization.


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Theories of Capitalisation:

The are two different theories of

Capitalisation :

Earning theory of Capitalisation

Cost theory o Capitalisation


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Earning Theory of Capitalisation

it recognises the fact that true value of an

enterprise depends upon its earning and the

expected fair rate of return on its capital

employed .

In short Capitalisation is equal to the capitalized

value of the estimated earnings.


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In real life it is very difficult to estimate correctly the

future earning as well as to determine the capitalisation

rate.

Future earning depends upon the number of factors such

as,

Demand for product

General price level.

Productivity of labour and so on.

These factors are beyond the control of management


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In the same manner, it is very difficult to

determine the capitalisation rate. As it depends

mainly on:

The expectations of investors

The degree of risk in particular firm.

In view of these difficulties, a newly establishedfirm prefers cost theory of capitalisation.

Where as earning theory of capitalisation is better

for the existing firms.


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For Example (Earning Theory of Capitalisation)

If a company is making a net profit of Rs.2,00,000 p.a.

and the fair rate of return is 10%.

The capitalization of the company will be

(2,00,000*100/10)= Rs.20,00,000

However this theory works only when the firms

expected income and capitalisation rate can precisely be

estimated.


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Cost theory ofCapitalisation

According to this theory Capitalisation is

arrived by adding up the cost of fixed assets

and working capital required for the

continuous operation of the company, the cost

of establishing the company and promotional

expenses.


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Over capitalisation

A company is said to be over capitalised when its

earnings are not sufficient to yield a fair return on

amount of shares or debentures.

In short, when a company is not in a position to

pay dividend or interest on its shares and

debentures at fair rates, is said to be over

capitalised.


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Misconception..

Over capitalisation implies a condition of excess

capital, actually speaking this notion is incorrect.

Over capitalisation does not always means anabundance of capital.

On the other hand, it is likely that an over

capitalised concern, there may be shortage of

capital.


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Over-capitalisation

Whenever the aggregates of the par value of

stocks and bonds outstanding, exceeds thetrue value of fixed assets the corporation is

said to be over capitalised.


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Fair Capitalisation Balance Sheet

Liability Amount Assets Amount

Share Capital

Debentures

Current liabilities

10,00,000

5,00,000

10,00,000

Fixed Assets

Current assets

15,00,000

10,00,000

25,00,000 25,00,000


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Over capitalised balance sheet


Share Capital

Debentures

Current liabilities

10,00,000

5,00,000

10,00,000

Fixed Assets

Current assets

12,00,000

13,00,000

25,00,000 25,00,000

In the above balance sheet, the fixed liabilities are excess of

fixed assets by Rs.3,00,000 and hence firm is said to be over -

capitalised


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Causes of Over Capitalisation

Over issue of Capital.

Purchasing property of inflated price.

Production and development during inflation.

High promotion cost.

In adequate depreciation.

Liberal dividend policy

Taxation policy.


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Disadvantages of over - capitalisation

It may lead to watered stock

Difficulty in raising fresh capital

Tendency to raise the price or deteriorate the quality of

product.

It may lead to company failure.

Difficulty in payment of interest.

Decrease in the value of shares and goodwill.

Loss of workers

Loss to share holders


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Effects of Over Capitalisation:

On Business:

Loss of goodwill.

Difficulty in obtaining loan.

Decline in efficiency of a company.

Liquidation of company.


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On shareholders:

Reduced dividends

Fall in the market value of shares.

Unacceptable as collateral securities.

Loss on reorganization.


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On society:

Loss to consumer.

Loss to worker

Gambling in shares

Leads to recession.


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Remedies for over capitalisation

Redemption of debts.

Reduction of interest rate on debts.

Redemption of preference stock.

Reduction in the par value of shares.

Reduction of number of shares of common stock


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Under Capitalisation

The corporation may be under capitalise when the

rate of profit on the total capital is exceptionally high,

in relation to the return enjoyed by similarly situatedcompanies in the same industry.

In simple words, under capitalisation stands for a

state of affairs when the capital of company is less in

proportion to its total capital requirements.


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Under capitalisation is associate with: -

An effective utilization of resources.

A high rate of dividend.

Enhance the market value of share


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Under Capitalised Balance Sheet


Share Capital

Debentures

Current liabilities

10,00,000

1,00,000

4,00,000

Fixed Assets

Current assets

12,00,000

3,00,000

15,00,000 15,00,000


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Causes of Under Capitalisation

Under estimation of capital requirement.

Under estimation of future earning.

Promotion during deflation.

Narrow dividend policy.

High efficiency.


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Disadvantages of under capitalisation

Limited marketability of shares.

Cut throat competition.

Rise in workers demand.

Dissatisfactions on the part of customers.

Dependence on outside sources of finance.

Danger of liquidation.


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Possible remedies for Under

Capitalisation

Splitting up of shares.

Increase in par value of shares.

Issue of bonus shares.


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Causes of watered stock

Valuing the services of promoters at unduly high

value and paying for their services in the form

stock. Acquiring assets of the company at too high price.

Acquisition of intangible assets such as patents,

goodwill at high value which latter proves

worthless.

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Capital is at Ion