CAPITALISATION
( FINANCIAL PLANNING)
( FINANCIAL PLANNING)
FINANCIAL MANAGEMENT/NET COMMERCE AND MANAGEMENT
BY DR. SHASHI AGGARWAL
CAPITALISATION
CONTENTS
1.
MEANING OF
CAPITAL
2.
CAPITALISATION
3.
THEORY OF
CAPITALISATION
4.
OVERCAPITALISATION
5.
UNDER CAPITALISATION
MEANING OF CAPITALISATION
1. DERIVED FROM
THE WORD CAPITAL
2. CAPITAL MEANS
: TOTAL AMOUNT OF CAPITAL EMPLOYED IN THE BUSINESS
3. CAPITAL IN
ACCOUNTING LITERATURE MEANS THE NET WORTH. NET WORTH MEANS ASSETS-MINUS
4. ECONOMISTS
USE THE TERM CAPITAL TO MEAN ALL ACCUMULATED WEALTH USED TO PRODUCE ADDITIONAL
WEALTH.
5. THE TOTAL
AMOUNT OF SHARE VALUE PAID AS SHOWN IN THE COMPANY’S BOOKS OF ACCOUNT
MEANING OF CAPITALISATION
COULD BE DEFINED IN TWO WAYS :
BROAD INTERPRETATION
:PROCESS OF DETERMINING THE PLAN OF FINANCING
QUANTITY AS WELL AS QUALITY OF FINANCING
1. TOTAL AMOUNT
OF CAPITAL
2. TYPE OF
SECURITIES
3.
PROPORTION OF THE VARIOUS
NAARROW INTERPRETATION :
QUANTITATIVE SENSE
1. PROCESS OF
DETERMINING THE QUANTUM OF FUNDS THAT A FIRM NEEDS TO RUN ITS BUSINESS.
2. GUTHMAN AND
DOUGALL:- IT IS SUM OF PAR VALUE OF STOCKS AND BONDS OUTSTANDING.
3.
CAPITALISATION IS THE SUM TOTAL OF LONG TERM
SECURITIES ISSUED BY A COMPANY AND SURPLUS NOT MEANT FOR DISTRIBUTION.
MEANING OF
CAPITALISATION
GILBERT HAROLD REFERS
TO CAPITALISATION AS ANY OF THE FOLLOWING CONCEPTS :
1. THE TOTAL PAR
VALUE OF ALL THE SECURITIES-SHARES AND DEBENTURES OUTSTANDING AT A GIVEN TIME
2. THE TOTAL PAR
VALUE OF ALL THE SECURITIES OUTSTANDING
AT A GIVEN TIME PLUS THE VALUATION OF ALL OTHER LONG TERM OBLIGATIONS
3. THE TOTAL
AMOUNT OF CAPITAL AND LIABILITIES OF CORPORATION I.E AMOUNT OF CAPITAL AND
STOCK
CAPITALISATION
IS THE SUM TOTAL OF LONG TERM SECURITIES ISSUED BY A COMPANY AND SURPLUS NOT
MEANT FOR DISTRIBUTION.
MODERN CONCEPT OF CAPITALISATION
IT INCLUDES:-
1. SHARE CAPITAL
2. LONG TERM
DEBTS
3. RESERVE AND
SURPLUS
4. SHORT TERM
DEBTS
5. CREDITORS
WALKER AND BAUGHN THE USE OF CAPITALISATION REFERS TO ONLY LONG TERM DEBT AND CAPITAL STOCK AND
SHORT TERM CREDITORS DO NOT CONSTITUTE SUPPLIERS OF CAPITAL IS ERRONEOUS. IN REALITY TOTAL CAPITAL IS FURNISHED BY SHORT TERM CREDITORS AND LONG TERM
CREDITOS
NEED OF CAPITALISATION:-
1. PROMOTION/INCORPORATION
2. EXPANSION
3. AMALGAMATION
4. REORGANIZATION
OF CAPITAL
CAPITAL ANC CAPITALISATION
TWO DIFFERENT TERMS
1. CAPITALISATION
IS USED ONLY IN RELATION TO COMPANIES AND NOT IN RELATION TO PARTNERSHIP FIRMS
OR SOLE
2. CAPITAL
REFERS TO THE TOTAL INVESTMENT OF A COMPANY IN MONEY,TANGIBLE AND INTANGIBLE
ASSETS.
3. TOTAL WEALTH
OF THE COMPANY
CAPITAL AND CAPITALISATION
CAPITALISATION
REFERS TO PAR VALUE OF SECURITIES : SHARES AND DEBENTURES PLUS ANY OTHER
RESERVES KEPT TO MEET LONG TERM AND PERMANENT NEED OF THE COMPANY.
CAPITALISATION IS ALSO DIFFERENT FROM SHARE CAPITAL
SHARE CAPITAL
MEANS PAID UP VALUE OF SHARES ISSUED BY
ISSUED BY COMPANY BUT EXCLUDES BONDS,DEBENTURES OR OTHER FORM OF BORROWING OF THE FIRM.
THEORY OF CAPITALISATION
1. THE COST
THEORY :ADDING UP THE COST OF FIXED ASSETS PLUS WORKING CAPITAL REQUIREMENTS.
AND THE PROMOTIONAL EXPENSES. SUITABLE FOR NEWLY ESTABLISHED COMPANY. NOT
SATISFACTORY AS IGNORE THE EARNING
CAPACITY.
2. THE EARNING
THEORY
THEORY OF
CAPITALISATION
1. DEPEND UPON
EARNING CAPACITY
2. EXPECTED FAIR
RATE OF RETURN
PROFIT
=3,00,000
FAIR
RETURN=10%
CAPITALISATION
=100/10 X 3,00,000
30,00,000
LOGICAL
THEORY. CORRELATES THE VALUE OF FIRM OR THE AMOUNT OF CAPTIALISATION DIRECTLY
WITH THE EARNING CAPACITY. CAN BE APPLIED IF FIRMS’S EXPECTED INCOME AND CAPITALISATION RATE CAN BE ESTIMATED.
TYPES OF CAPITALIZATION
1. FAIR
CAPITALISATION
2. OVER
CAPITALISATION
3. UNDERCAPITALISATION
FAIR CAPITALISATION : NEITHER OVER CAPITALIZED NOR UNDER CAPITALIZED
OVER CAPITALISATION
1. WHERE
EARNINGS OF COMPANY DO NOT JUSTIFY THE AMOUNT OF CAPITAL INVESTED IN ITS
BUSINESS.
2. MORE CAPITAL
THAN ACTUALLY REQUIRED
3. ANNUAL EARNING =3,00,000 AND FAIR RATE OF
RETURN =15%
4. 300000X100/15=20,00,000
5. BUT CAPITAL
INVESTED IS 40,00,000
6. ACTUAL
EARNING =( 3,00,000/40,000,00)X100=7.5%
OVER CAPITALISATION
GRESTENBERG,”
A COMPANY IS OVERCAPITALISED WHEN EARNING ARE NOT LARGE ENOUGH TO YIELD A FAIR
RETURN ON THE AMOUNT OF STOCK AND BONDS THAT HAVE BEEN ISSUED OR WHEN THE
AMOUNT OF SECURITIES OUTSTANDING EXCEEDING THE CURRENT VALUE OF THE ASSETS.
OVER
CAPITALISATION ARISE WHEN THE EARNING OF THE COMPANY ARE NOT SUFFICIENT TO GIVE
A NORMAL RETURN OF CAPITAL EMPLOYED.
1. ACQUIRING OF FICTITIOUS ASSET LIKE GOODWILL AT HIGHER PRICE
2. PURCHASING ASSETS DURING INFLATION
3. ASSETS SHOWN
AT HIGHER VALUE DUE TO DEFECTIVE DEPRECIATION POLICY
4. MAIN SIGN
IS FALL IN RATE OF DIVIDEND AND MARKET VALUE OF THE SHARES.
OVER CAPITALISATION AND EXCESS OF CAPITAL
DIFFERENCE BETWEEN EXCESS CAPITAL AND OVERCAPTIAL
ABUNDANCE OF
CAPITAL MAY BE THE ONE REASON OF OVERCAPITALISATION
OVER
CAPITALISATION ARISES WHEN THE EXISTING CAPITAL OF A FIRM IS NOT EFFECTIVELY
UTILIZED WITH THE RESULT THAT THERE IS A FALL IN THE EARNING CAPACITY
MAIN SIGN OF OVERCAPITALISATION :
- FALL IN THE
RATE OF DIVIDEND
- MARKET VALUE OF
THE SHARES
- CAUSES
- OVER ISSUE OF
CAPITAL : OVERESTIMATING THE FINANCIAL
- PROMOTION,FORMATION
DURING INFLATION
- PURCHASE OF
ASSETS DURING INFLATION
- INADEQUATE
DEPRECIATION
- HIGH RATE OF
DIVIDEND
- TAXATION POLICY
- HIGHER RATE OF
INTEREST
- HIGH PROMOTION
EXPENSES
- INADEQUATE
DEMAND FOR PRODUCTS
- IF THE RATE OF
CAPITALISATION IS UNDER ESTIMATED IT WILL LEAD TO A SITUATION OF
OVERCAPITALISAING
EFFECT OF CAPITALISATION ON THE COMPANY
1. LOSS OF
GOODWILL : REDUCED EARNING CAPACITY--- FALL IN THE MARKET SHARES----SHAKING THE
INVESTOR’S CONFIDENCE
2. POOR
CREDITWORTHINESS : DIFFICULT TO GET LOANS AT CHEAPER RATES OF INTEREST
3. DIFFICULT TO
GET FURTHER CAPITAL FOR EXPANSION AND CAPITAL
4. DECLINE IN
THE EFFICIENCY OF CAPITAL : INADEQUATE PROVISION FOR DEPRECIATION
5. FAILS TO
PRODUCE GOODS AT COMPETITIVE PRICES AND LOSS OF MARKET
6. MANIPULATION
OF PROFITS
7. LIQUIDATION
OF COMPANY
EFFECT OF CAPITALISATION ON THE SHAREHOLDERS
1. REDUCED DIVIDEND
2. FALL IN THE
MARKET SHARES
3. THE SHARES OF
OVER CAPITALIZED COMPANY HAVE SMALL VALUE AS COLLATERAL SECURITY. BANKS AND
FINANCIAL INSTITUTIONS ARE RELUCTANT TO LEND MONEY AGAINST SUCH SECURITIES
4. LOSS ON
SPECULATION : PRICES OF SHARES ARE UNSTABLE
5. LOSS OF
REORGANIZATION : AND REDUCTION OF
EFFECT OF OVER CAPITALISATION ON THE
SOCIETY
1. LOSS TO
CONSUMER : PAY MORE FOR LOW QUALITY PRODUCTS
2. LOSS TO
WORKERS : REDUCE WAGES AND WELFARE FACILITIES
3. UNDER UTILIZATION OF RESOURCES
4. GAMBLING IN
SHARES
5. LEADS TO
INCREASED LOSSES,POOR QUALITY OF PRODUCTS,RETRENCHMENT OR UNEMPLOYMENT, ENTIRE
INDUSTRY AND SOCIETY AND MAY LEAD TO RECESSION
REMEDIES
1. TO HAVE
EFFICIENT MGMT
2. REDEMPTION OF
PREFERENCE SHARES
3. REDUCTION OF
FUNDED DEBT : DEBENTURES,PUBLIC DEPOSITS AND LOAN TAKEN AT HIGHER RATES SHOULD
BE PAID OUT OF ACCUMULATED PROFITS
4. REORGANIZATION
OF EQUITY SHAREHOLDERS. WRITE OFF FICTITIOUS ASSETS AND OTHER OVERVALUED
ASSETS.
UNDERCAPITALISATION
MEANING OF
UNDER CAPITALISATION
- A COMPANY IS
SAID TO BE UNDER CAPITALIZED WHEN ITS EARNING A VERY HIGH RATE OF PROFIT
AS COMPARED TO OTHER COMPANIES OR THE VALUE OF THE ASSETS IS SIGNIFICANTLY
HIGHER THAN CAPITAL RAISED.
- FOR EXAMPLE THE
CAPITALISATION IS 30 LACS AND THE AVERAGE RATE OF RETURN IS 20% BUT
COMPANY IS EARNING 35%. IT IS A CASE OF UNDER CAPITALISATION
- OCCURS WHEN A
COMPANY’S ACTUAL CAPITALISATION IS LOWER THAN PROPER CAPITALISATION AS
WARRANTED BY ITS EARNING CAPACITY. THE REAL VALUE IS MORE THAN ITS BOOK
VALUE. PROFITS ARE HIGHER AND MARKET VALUE OF THE SHARES IS MUCH HIGHER
THAN ITS FACE VALUE.
GRESTENBERG,”
A COMPANY MAY BE UNDER-CAPITALIZED 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.
CAUSES
1. THE ASSETS
HAVE BEEN ACQUIRED AT THE LOWER RATES OR
2. THE COMPANY
HAS GENERATED SECRET RESERVES BY PAYING LOWER RATE OF DIVIDEND
3. UNDER-ESTIMATION
OF CAPITAL REQUIREMENTS: MAY LEAD TO CAPITALISATION WHICH IS INSUFFICIENT TO RUN
THE BUSINESS
4. UNDER
–ESTIMATION OF FUTURE EARNINGS AT THE TIME OF PROMOTION
5. PROMOTION
DURING DEPRESSION
6. CONSERVATIVE
DIVIDEND POLICY
7. VERY
EFFICIENT. IT MAY ISSUE THE MINIMUM SHARE CAPITAL AND MAY MEET THE ADDITIONAL FINANCIAL REQUIREMENTS THROUGH BORROWING AT LOWER RATE OF INTEREST.
8. DESIRE OF
CONTROL AND TRADING TO EQUITY
EFFECT OF UNDER CAPITALISATION
ON
SHAREHOLDERS:-
•
PROFITABILITY WILL BE HIGH SO EPS WILL BE HIGH
•
VALUE OF THE EQUITY SHARE WILL GO UP
•
FINANCIAL REPUTATION WILL INCREASE
•
EXPECTATION OF REGULAR DIVIDEND BY SHAREHOLDERS
EFFECT ON COMPANY
1. INCREASE IN
THE FINANCIAL REPUTATION OF THE FIRM
2. SECRET
RESERVE
3. WILL ATTRACT COMPEITION IN THE MARKET
4. MORE AND
HIGHER WAGES WILL BE DEMANDED BY THE WORKERS
5. CUSTOMER MAY
FEEL THEY ARE OVERCHARGED
6. TAX MAY BE
INCREASED BY THE GOVT
EFFECT ON SOCIETY
1. UNHEALTHY
SPECULATION IN SHARES
2. FEELING OF
EXPLOITATION
3. BUILD UP
SECRET RESERVE AND PAY LOWER TAX
4. REMEDIES TO
CORRECT UNDERCAPITALISATION
5. FRESH ISSUE
OF SHARES
6. ISSUE OF
BONUS SHARES
7. INCREASING
THE FACE VALUE: BY INCREASING THE PAR VALUE /NUMBER OF EQUITY SHARES
8. SPLITTING THE
STOCK
COMPARISON
OVER CAPITALISATION
1. GREAT STRAIN
ON THE FINANCIAL RESOURCES OF COMPANY
2. REMEDIAL
PROCESS IS MORE DIFFICULT AND EXPENSIVE
3. ADVERSELY AFFECT THE STAKEHOLDERS AND ECONOMIC STABILITY AND SOCIAL PROSPERITY
4. COMMON
UNDERCAPITALISATION
1. HIGH EARNING
POWER
2. LESS
DIFFICULT
3. CUT THROAT
COMPETITION
4. RARE
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