Overcapitalization indicates a situation of over-funding i.e.: the company has raised excessive funds as compared to its current requirements. Undercapitalization indicates a situation of under-funding i.e.: the company does not have enough funds/cash flow to meet the current needs of its business operations.
What is Overcapitalization and its causes?
Over-capitalisation may be the result of the following factors: (i) Acquisition of Assets at Higher Prices: Assets might have been acquired at inflated prices or at a time when the prices were at their peak. In both the cases, the real value of the company would be below its book value and the earnings very low.
What is the meaning of overcapitalization?
Overcapitalization occurs when a company has more debt than its assets are worth. A company that is overcapitalized may have to pay high interest and dividend payments that will eat up its profits.
What are the causes of overcapitalization?
- Over-issue of capital:
- Acquiring assets at inflated prices:
- Formation during the boom period:
- Over estimation of earnings:
- Inadequate depreciation:
- Liberal dividend policy:
- Lack of reserves:
- Heavy promotion and organisation expenses:
What are the effects of undercapitalization?
The effects of under-capitalisation on the society are as follows: (i) Under-capitalisation may lead to higher profits and higher prices of shares on the stock exchange. This may encourage unhealthy speculation in its shares. (ii) Because of higher profits, the consumers feel exploited.
How is Overcapitalization different from Undercapitalization?
Indicates. Overcapitalization indicates a situation of over-funding i.e.: the company has raised excessive funds as compared to its current requirements. Undercapitalization indicates a situation of under-funding i.e.: the company does not have enough funds/cash flow to meet the current needs of its business operations …
Why is over capitalization bad?
It creates problems with re-organization. It leads to the underutilization of available resources. It also leads to a higher rate of taxation on the income statement. read more of the company.
How do you reduce capitalization?
Remedies of Over-Capitalisation:
Various remedial measures such as reduction in bonded debt, reduction of rate of interest paid on debentures, redemption of high dividend preferred shares, reduction of par value of shares and reduction of number of shares are suggested.
What is the significance of cost of capital?
Cost of capital represents a hurdle rate that a company must overcome before it can generate value, and it is used extensively in the capital budgeting process to determine whether a company should proceed with a project. The cost of capital concept is also widely used in economics and accounting.
- Dividends for preference shareholders.
- Preference shareholders have no right to vote in the annual general meeting of a company.
- These are a long-term source of finance.
- Dividend payable is generally higher than debenture interest.
- Right on assets when the company is liquidated.
How can Overcapitalization pose problems?
- Decline in dividend rate: A declining dividend rate due to overcapitalization undermines a firm’s reputation and future prospects.
- Fundraising difficulties: When the dividend rate falls, the market value of shares also falls.
What are the causes and effects of under-Capitalisation?
Causes of under-capitalization
Financing growth with short-term capital, rather than permanent capital. Failing to secure an adequate bank loan at a critical time. Failing to obtain insurance against predictable business risks. Adverse macroeconomic conditions.
What are the goals of financial management?
- Profit Maximization. Profit maximization is a stated goal of financial management. …
- Profitability Maximization. …
- EPS Maximization. …
- Liquidity Maximization.
What are the objectives of financial management?
The primary objectives of financial management are: Attempting to reduce the cost of finance. Ensuring sufficient availability of funds. Also, dealing with the planning, organizing, and controlling of financial activities like the procurement and utilization of funds.
Share is the capital of the company, but Debenture is the debt of the company. The shares represent ownership of the shareholders in the company. On the other hand, debentures represent indebtedness of the company. The income earned on shares is the dividend, but the income earned on debentures is interest.
What are the theories of capitalisation?
There are two important theories to determine the amount of capitalisation: (i) The Cost Theory, and (ii) The Earnings Theory. (i) The Cost Theory of Capitalisation: According to this theory, the amount of capitalisation is equal to the total cost incurred in setting of a corporation as a going concern.