1. Do you know the theories to determine the amount of capitalization?
The two main theories which are involved with the amount of capitalization are as follows:-
1) Cost Theory - In this theory the value of the company is decided by adding certain factors such as:-
(i) Cost of fixed assets i.e. Machinery, mechanical items
(ii) Working capital i.e. the capital which is required for continuous operation of the company
(iii) Cost of establishment of business promotion i.e. Expenses in doing the advertisements
These factors allow the promotion team to know the amount of capital which has to be raised to fulfill the promotion job. The true income of the company is been found out by its earning not by its investment in other states. For example if some assets becomes out of date and some idle then the earnings will fall but that fall of capital won't affect the investment made by the company in other company's business.
2) Earnings Theory: In this theory true value of an enterprise depends on its earnings capacity. The value of the company capitalization will be same as the estimated earning of the company. To find out this a company has to prepare a profit and loss account and then check regularly to see the effect of their sales over the years to find out how correct there estimations are. The earnings will be compared to the actual earning and the adjustment will be made according to that. The promotion team will then see the up and down of the earnings and then overall decision will be taken on management and how to simulate the earning to increase the revenue of the company.
For example if there is a company which has an estimated average profit of Rs. 25,000 in first few years and earning a return of 5% on their capital. The capitalization will be: (25,000*100)/5 = Rs. 5, 00,000
In this theory true value of an enterprise depends on its earnings capacity. The value of the company capitalization will be same as the estimated earning of the company. To find out this a company has to prepare a profit and loss account and then check regularly to see the effect of their sales over the years to find out how correct there estimations are. The earnings will be compared to the actual earning and the adjustment will be made according to that. The promotion team will then see the up and down of the earnings and then overall decision will be taken on management and how to simulate the earning to increase the revenue of the company.
For example if there is a company which has an estimated average profit of Rs. 25,000 in first few years and earning a return of 5% on their capital. The capitalization will be: (25,000*100)/5 = Rs. 5, 00,000
In this theory the value of the company is decided by adding certain factors such as:-
(i) Cost of fixed assets i.e. Machinery, mechanical items
(ii) Working capital i.e. the capital which is required for continuous operation of the company
(iii) Cost of establishment of business promotion i.e. Expenses in doing the advertisements
These factors allow the promotion team to know the amount of capital which has to be raised to fulfill the promotion job. The true income of the company is been found out by its earning not by its investment in other states. For example if some assets becomes out of date and some idle then the earnings will fall but that fall of capital won't affect the investment made by the company in other company's business.
4. Tell me what is over capitalization? What are its causes?
Capitalization of a company neither should be low or high. It should be suitably available at the time of need. Over capitalization is a state in which the earning which are not sufficient to give a good return on the amount of share capital which has been issued. This is where when total owned and borrowed capital exceeds the fixed and current assets (it shows losses on the assets side). The company which comes under this state is like a person who can't carry his own weight properly. The company which comes under this kind of influence has many difficulties and not likely to be active until the state is been corrected. The causes of over capitalization are as follows:
1) Idle Funds: Company may have funds which might not have been used properly e.g. Money invested in such projects that are giving very low profits.
2) Over-valued : Fixed assets may be having higher cost than that of its actual cost.
3) Value degradation : Fixed assets may have been taken when the prices were high and when the prices have fallen the value of it may have fallen but then also the value for the company will be high only.
4) Inadequate Depreciation provision: Fixed assets might not have adequate provision.
5. Do you know what is capitalization? What is its importance?
Capitalization is a term which has different meanings in both financial and accounting context. Capitalization in accounting means the cost to buy an asset which is included in the price of the asset whereas in financial terms it is the cost which is required to buy an asset which includes price of a particular asset and it also include the retained earnings of a company with stock debt and long term debt. There are two kinds of capitalization which are called as Over-capitalization and another is called as Under-capitalization. Capitalization is very import aspect in determining the value of the company in the market which is based on the economic structure of the company. This aspect depends on the previous records and economics of the company. This also shows a particular behaviour of the companies' structure and allows them to create a plan to do the marketing.
6. What are the causes of undercapitalization?
The effect of undercapitalization can be summarized as:-
(i) The payment of excessive interest on borrowed capital can lead to under capitalization as we have to pay more interest on the capital which has been borrowed from some other dealers around.
(ii) Under capitalization can also cause companies to use their old and out of date equipment because of inability to buy new items or purchase new items.
(iii) Under capitalization allows the companies to run on low cost because of that they are unable to have high cost of production due to use of old machinery. It is also a cause of improper financial planning. It is difficult to raise the capital if any company comes under this sort of situation. There are several different causes that exist such as:-
- It makes a company growing financially with short-term capital, rather than having permanent capital to spend on goods and on purchasing.
- It doesn't allow a secure transaction of bank loan at critical time.
- In during the predictable business risk it also fails to obtain the insurance cost.
- It also has to go through many adverse macroeconomic conditions
7. What is undercapitalization?
Under capitalization is any situation which restricts the business companies to acquire the funds which they need. Under capitalization is also a state like over capitalization where the owned capital of the business is much less than the borrowed capital. It also means that the owned capital of the company is not up to the scale and its operation and business depends on the borrowed money. This also comes as a result of over-trading. Under capitalization has many factors involved with it and it is indicated by:
(i) Low proprietary Ratio
(ii) Current Ratio
(iii) High Return on Equity Capital
8. What is Inadequate Depreciation provision?
Fixed assets might not have adequate provision.
Fixed assets may have been taken when the prices were high and when the prices have fallen the value of it may have fallen but then also the value for the company will be high only.
Fixed assets may be having higher cost than that of its actual cost.
