Differentiate between over-capitalization and under-capitalization

Differentiate between over-capitalization and under-capitalization 

"Both over-capitalization and under-capitalization are undesirable .
However , of the two , the state of over-capitalization is more fatal and dangerous" 

(#) Capitalization 

* Capitalization means amount of capital invested in a business .

* Capitalization is used in the case of companies only .

* Capitalization includes all the sources of fund used in an organization .  

------> " The term capitalization or the valuation of the capital includes the capital stock and debts "

* "Capitalization " has been derived from the term ' capital ' . Capitalization is used in relation to companies and not in partnership from of sole business . 


*Capitalization  = Share capital + Preferential share capital  


(#) Over-capitalization   

* " A corporation is over-capitalized when its earning are not large enough to yield ( Provide ) a fair return on the amount of stocks and bonds that have been issued , or when the amount of securities outstanding exceeds the current value of the assets "

* The earning are insufficient to pay dividend and interest .

 (#) Characteristic of  Over-capitalization   

* Lower rate of earning 

* Lower rate of dividend

* Low market value of shares

(#) Causes Over-capitalization 

* Borrowing at high rate of interest

* Over estimation of future earners.

* Assets acquired at inflated price

(#) Disadvantage of Over-capitalization 


 (*) Disadvantage for company 

* Decrease in the share's value

* Difficulty in obtaining capital

* Demand for liquidation 

(*) Disadvantage for shareholder

* Shareholder get low dividend 

* The market value of share decreases  

(*) Disadvantage for society 

* Labour may get low wages

* Condition of unemployment can be arise

* It leads to wastage of national resources

(#) Remedies of Over-capitalization 

Under the scheme of capital reduction

* Reduction in the rate of interest payable on debenture.

* Reduction in the rate of preference dividend .

* Reduction in number of shares .

*Enhance earning capacity by increase in efficiency of human and non-human resources .


(#) Under-capitalization

" When a corporation earns exceedingly high income on its capital , it is said to under-capitalized "

(#) Causes of  under-capitalization

* The assets have been acquired at lower rate

* The company has generated secret reserves by paying lower dividend ( Conservative dividend policy ) to the shareholder over a number of year .

(#) Indicators of under-capitalization

* Unforeseen increase in earnings .

* High standard of efficiency ( borrowing at lower rates of interest )

(#) Effect on shareholder

* The rate of earning per share will go up .

* The value of its equity share in the market will go up .

* Shareholder expect higher dividends regularly .

(#) Advantage of under-capitalization

* High dividends

* Company get finance or loans easily .

* It enhance the opportunity and benefit for employees .


(#) Disadvantage of under-capitalization

* Government interference
     It may attract government control and higher taxation .

* Negative massage to consumer
   It may give the consumers a feeling that they are being exploited      by the company

(#) Remedies of under-capitalization

* Issue of bonus shares 
   Firm may Convert reserve into shares or reduce dividend per            shares and overall rate of earning .

* Issue of shares and Debenture to public