Question

What is capital reduction? Elaborate out the steps to be followed at the time of formulating a scheme of capital reduction.

Answer 1

Answer:

Reduction of capital or capital reduction is to decrease stock of a company. During reduction of capital, sometimes the company returns a portion of the stock of a company to shareholder.

Answer 2

Answer:

Definition of Capital reduction :

• Capital reduction, commonly referred to as share buybacks, is the process of reducing a company's shareholder equity through share cancellations and repurchases.
• Companies reduce capital for a variety of reasons, including boosting shareholder value and creating a capital structure that is more effective.
• Following a capital reduction, the company's shares will be reduced by the same amount.
• While such a move won't affect the company's market value, it will decrease the float, or the number of shares that are outstanding and can be traded.

Capital Reduction Step 1 is Determination of Total Loss :

• The whole amount of the loss that needs to be written off should be determined first.
• This includes any decrease in asset value, any increase in liability, any arrears of cumulative preference dividend, etc., as well as the debit balance of the profit and loss account and all fictitious assets, such as goodwill, preliminary expenses, discounts on the issuance of shares and debtentures, etc. In essence, nothing is left but net assets.

Step 2 of the capital reduction process is writing off the determined loss :

• It becomes required to lower the capital contributions made by the different parties, including equity shareholders, preference shareholders, unsecured creditors, and creditors with a floating charge, after determining the overall loss.
• The above people experience the loss. Equity shareholders are expected to lose the most money practically.
• Since they are fully aware that their capital is completely nonexistent in actuality, they also agree to accept the loss to the fullest extent possible.
• Therefore, if the business is liquidated, they will receive nothing.

Step 3 of the capital reduction process is the payment of compensation by various parties :

• The way that loss is allocated to the different stakeholders depends on the situation.
• The issue of compensation does not come up if the loss is to be borne solely by the equity shareholders with the understanding that the loss will ultimately be made up for by future earnings.
• However, if preference shareholders are required to make any sacrifices (i.e., if they are to share the amount of loss), they must be made up for it by having their dividend rate increased in a way that prevents the capital decrease from having an impact on their overall earnings.
• A business can only implement the same strategy when its earnings trend is stable.

Step Four of Capital Reduction: Organizing Working Capital :

Following are the steps included in this step :

(i) issuing a number of shares;

(ii) to ask the holders of debentures to extend their loans;

(iii) to make the share capital partially paid so that the remaining payments can be made as needed;

(iv) to invite any new loans; and (short-term).

#SPJ3