What is capitalization ? | What do you mena by Capitalization?

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Capitalization is one of most important part of financial decision, which is related to the total amount of capital employed in the business.

Understanding the concept of capitalization leads to solve many problems in the field of financial management. Because there is a confusion among capital, capitalization and capital structure.

Capitalizations refers to the process of determining the quantum of funds that a firm needs to run its business. Capitalization is only the par value of share and debenture and it does not include reserve and surplus.

Types of capitalizations

Overcapitalization

Under capitalization

Water capitalization

Over capitalization

Over capitalization refers to the company which possesses an excess of the capital in relation to its activity level and requirement. In simple means, over capitalization is more capital then actually required and the fund are properly used.

Causes of over capitalization:

Over issue of capital by company

Borrowing large amount of capital at higher rate of interest

Providing inadequate depreciation to the fixed assets.

Excessive payment for acquisition of goodwill.

High rate of taxation

Under estimation of capitalization rate. 

Effect of over capitalization

Reduce the rate of earning capacity of shares.

Difficulty in obtaining necessary capital to the business concern

Its leads to the fall in the market price of shares.

It creates the problem re-organization.

Under capitalization

Under capitalization is the opposite concept of over capitalization and it will occur when the company’s actual capitalization is lower than the capitalization as warranted by its earning capacity.

Causes of under capitalization

Under estimation of capital requirement

Under estimation of initial and future earning

Maintaining high standard of efficiency.

Effect of under capitalization

It leads to manipulate the market value of shares

It increases the marketability of shares.

It may lead to more government control and higher taxation

It leads to higher competition.

Remedies of under capitalization

Under capitalization can be compensated with the help of fresh issue of shares.

Increase the par value of shares may help to reduce under capitalization

Reducing the dividend per share by the way of splitting up shares.

Water Capitalization

It the stock or capital of the company is mentioned by assets of equipment value, it is called the water stock. In the simple words, watered capital means that the realized value of assets of the company is less than its book value.


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