Over Capitalization:
Over capitalization refers to the company which possesses an excess of capital in relation to its activity level and requirements. In simple means, over capitalization is more capital than actually required and the funds are not properly used.
According to Bonneville, Dewey and Kelly, over capitalization means, “when a business is unable to earn fair rate on its outstanding securities”.
Example:
A company is earning a sum of Rs. 50,000 and the rate of return expected is 10%. This company will be said to be properly capitalized. Suppose the capital investment of the company is Rs. 60,000, it will be over capitalization to the extent of Rs. 1,00,000. The new rate of earning would be:
50,000/60,000×100=8.33%
When the company has over capitalization, the rate of earnings will be reduced from 10% to 8.33%.
Causes of Over Capitalization:
Over capitalization arise due to the following important causes:
• Over issue of capital by the company.
• Borrowing large amount of capital at a higher rate of interest.
• Excessive payment for acquisition of goodwill.
• High rate of taxation.
• Under estimation of capitalization rate.
Effects of Over Capitalization:
Over capitalization leads to the following important effects:
• Reduce the rate of earning capacity of the shares.
• Difficulties in obtaining necessary capital to the business concern.
• It leads to fall in the market price of the shares.
• It creates problems on re-organization.
• It leads under or misutilisation of available resources.
Remedies for Over Capitalization:
Over capitalization can be reduced with the help of effective management and systematic design of the capital structure. The following are the major steps to reduce over capitalization.
• Efficient management can reduce over capitalization.
• Redemption of preference share capital which consists of high rate of dividend.
• Reorganization of equity share capital.
• Reduction of debt capital.
Over capitalization refers to the company which possesses an excess of capital in relation to its activity level and requirements. In simple means, over capitalization is more capital than actually required and the funds are not properly used.
According to Bonneville, Dewey and Kelly, over capitalization means, “when a business is unable to earn fair rate on its outstanding securities”.
[Post Image Courtesy of Stuart Miles at FreeDigitalPhotos.net]
Example:
A company is earning a sum of Rs. 50,000 and the rate of return expected is 10%. This company will be said to be properly capitalized. Suppose the capital investment of the company is Rs. 60,000, it will be over capitalization to the extent of Rs. 1,00,000. The new rate of earning would be:
50,000/60,000×100=8.33%
When the company has over capitalization, the rate of earnings will be reduced from 10% to 8.33%.
Causes of Over Capitalization:
Over capitalization arise due to the following important causes:
• Over issue of capital by the company.
• Borrowing large amount of capital at a higher rate of interest.
• Excessive payment for acquisition of goodwill.
• High rate of taxation.
• Under estimation of capitalization rate.
Effects of Over Capitalization:
Over capitalization leads to the following important effects:
• Reduce the rate of earning capacity of the shares.
• Difficulties in obtaining necessary capital to the business concern.
• It leads to fall in the market price of the shares.
• It creates problems on re-organization.
• It leads under or misutilisation of available resources.
Remedies for Over Capitalization:
Over capitalization can be reduced with the help of effective management and systematic design of the capital structure. The following are the major steps to reduce over capitalization.
• Efficient management can reduce over capitalization.
• Redemption of preference share capital which consists of high rate of dividend.
• Reorganization of equity share capital.
• Reduction of debt capital.
Over Capitalization Definition And Meaning
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Sunday, April 02, 2017
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