Question

"The consequences of over - capitalization are far more serious and fatal than under-capitalization" discuss

Answer 1

Over-capitalization

When a company is not able to pay interest on debentures and loans and ensure a fair return to the shareholders it is considered to be over-capitalized.

Under-capitalization

When a company's actual capitalization is lower than its proper capitalization as warranted by its earning capacity the company is considered to be under-capitalized. Under-capitalization can have some negative consequences like consumer dissatisfaction, creation of power competition, possibility of manipulating share value and labour unrest.

The effects of over-capitalization are far more serious and fatal than under-capitalization.

Effects on a company:

1. It may not be easy to sell the shares of the company in the market because of the reduced earnings per share.

2. It may not be possible for the company to raise fresh capital from the market.

3. The management may be compelled to follow unfair practices due to reduced earnings. Accounts may be manipulated to show higher profits.

4. Expenditure on maintenance and replacement of assets may be cut down.

5. The reputation of the company may be suffer due to low earnings.

Effects on shareholders:

1. Shareholders get lesser dividends.

2. The market value of shares is reduced due to lower profitability.

3. There may be no certainty of income in the future.

4. The face value of the equity share may be lowered in case of reorganization.

Effects on society:

1. There would be a declining trend in the profits of an over-capitalized company. Such a company may increase the price of the product or reduce its quality.

2. Return on capital employed is very less. This implies that the financial resources of the public are not utilized properly.

3. The company may not be able to pay interest to the creditors on a regular basis.

4. The company may not be able to provide adequate wages to the workers or better working conditions.

Answer 2

Capitalization has different meaning in both finance and accounting. In accounting capitalization is when the cost to get an asset are expended over the life of that asset itself rather than in the period it was contract(debt). in finance however, it means a sum of a company's stocks, goods and services, returned earning and debt incurred. Under capitalization therefore is when a company is unable to meet the payment of business operations. it's also a situation whereby a company do not have enough capital or money to perform operation of transaction and also to pay creditors. Capitalization however is more fatal and serious than under capitalization because manipulation of financial statements often happen, in capitalization aswell the capital depends in the price of stocks, and lastly the profit is often inflated.