Capitalization is defined as the sum of the par value of stocks and bonds outstanding”. Is one of the most important parts of financial decision, which is related to the total amount of capital employed in the business concern.
Understanding the concept of capitalization leads to solve many problems in the field of financial management. Because there is a confusion among the capital, capitalization and capital structure.
Meaning of Capitalization
It refers to the process of determining the quantum of funds that a firm needs to run its business. Is also the only par value of share capital and debenture and it does not include reserve and surplus.
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Financial planning and decision play a major role in the field of financial management which consists of the major area of financial management such as, capitalization, financial structure, capital structure, leverage and financial forecasting.
Financial planning includes the following important parts:
●Estimating the amount of capital to be raised.
●Determining the form and proportionate amount of securities.
●Formulating policies to manage the financial plan.
MEANING OF CAPITAL
The term capital refers to the total investment of the company in terms of money, and assets. It is also called as total wealth of the company. When the company is going to invest large amount of finance into the business, it is called as capital. Capital is the initial and integral part of new and existing business concern.
The capital requirements of the business concern may be classified into two categories:
Fixed capital is the capital, which is needed for meeting the permanent or long-term purpose of the business concern. Fixed capital is required mainly for the purpose of meeting capital expenditure of the business concern and it is used over a long period. It is the amount invested in various fixed or permanent assets, which are necessary for a business concern.
Definition of Fixed Capital
Fixed capital is comparatively easily defined to include land, building, machinery and other assets having a relatively permanent existence”.
Character of Fixed Capital
●Fixed capital is used to acquire the fixed assets of the business concern.
●Fixed capital meets the capital expenditure of the business concern.
●Fixed capital normally consists of long period.
●Fixed capital expenditure is of nonrecurring nature.
●Fixed capital can be raised only with the help of long-term sources of finance.
Working capital is the capital which is needed to meet the day-to-day transaction of the business concern. It may cross working capital and net working capital.working capital consists of various compositions of current assets such as inventories, bills, receivable, debtors, cash, and bank balance and prepaid expenses.
Working Capital Definition
Working capital is define as “any acquisition of funds which increases the current assets increase the Working Capital also for they are one and the same”.
Working capital is needed to meet the following purpose:
●Purchase of raw material
●Payment of wages to workers
●Payment of day-to-day expenses
●Maintenance expenditure etc.
Definition of Capitalization
Capitalization can be defined as the sum of the par value of stocks and bonds outstanding”.
TYPES OF CAPITALIZATION
Capitalization may be classified into the following three important types based on its nature:
Over capital refers to the company which possesses an excess of capital in relation to its activity level and requirements. In simple means, over capitalization is more capital than actually required and the funds are not properly used.
Over capitalization means, “when a business is unable to earn fair rate on its outstanding securities”.
Causes of Over Capitalization
Over capitalization arise due to the following important causes:
•Borrowing large amount of capital at a higher rate of interest.
•Excessive payment for acquisition of goodwill.
•High rate of taxation.
•Under estimation of capitalization rate.
Effects of Over Capitalization
Over capitalization leads to the following important effects:
•Reduce the rate of earning capacity of the shares.
•It leads to fall in the market price of the shares.
•It creates problems on re-organization.
Remedies for Over Capitalization
Over capitalization can be reduced with the help of effective management and systematic design of the capital structure.
•Efficient management can reduce over capitalization.
•Reorganization of equity share capital.
•Reduction of debt capital.
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. Under capitalization is not the so called inadequate capital.
Under capitalization is define as “a corporation may be under capitalized when the rate of profit is exceptionally high in the same industry”.
Causes of Under Capitalization
Under capitalization arises due to:
•Under estimation of capital requirements.
•Maintaining high standards of efficiency.
•Desire of control and trading on equity.
Effects of Under Capitalization
Under Capitalization leads certain effects in the company and its shareholders.
•It leads to manipulate the market value of shares.
•It may lead to more government control and higher taxation.
•Consumers feel that they are exploited by the company.
•It leads to high competition.
Remedies of Under Capitalization
Under Capitalization may be corrected by taking the following remedial measures:
1.Under capitalization can be compensated with the help of fresh issue of shares.
2.Increasing the par value of share may help to reduce under capitalization.
3.Under capitalization may be corrected by the issue of bonus shares to the existing shareholders.
4.Reducing the dividend per share by way of splitting up of shares.
If the stock or capital of the company is not mentioned by assets of equivalent value, it is called as watered stock. In simple words, watered capital means that the realizable value of assets of the company is less than its book value.
Causes of Watered Capital
Generally watered capital arises at the time of incorporation of a company but it also arises during the life time of the business.
1.Acquiring the assets of the company at high price.
2.Adopting ineffective depreciation policy.
3.Worthless intangible assets are purchased at higher prices.