What is Capitalisation?

Capital is an initial investment in a business or company which helps to start a business. It is money which is invested by company's owner to make more money. There are two type of capital in a business: Fixed capital and working capital.

Fixed capital: It is a permanent source of capital invested in a business. The capital are invested in machinery, land, furniture, buildings which provides long term funds and also help to run the business.

Working capital: It is capital which is needed to meet day to day expenses or help to run the business smoothly. It is a difference between current assets and current liabilities. A current liability is short term money owe by company and current assets are those assets which are converted into cash within a month. Company must have enough current assets to pay all current liabilities. It includes cash, inventory, debtors, prepaid expenses etc.

Capitalisation: It is a total value of capital employed in a business. It includes shares, debentures etc which help to run the business.

Types of Capitalisation:

There are three types of capitalisation i.e.

·         Under capitalisation

·         Over capitalisation

·         Watered capitalisation

Under capitalisation: In under capitalisation the total value of capital is less than the capital needed to run the business. It is not good for the business because

·         It affects day to day business activity.

·          If the capital is not enough to pay its debt on time it also affect the credibility of a company.

·         And if business operation is affected then it also affects the profitability of a business.

·         If company is not able to earn profit and are not able to pay dividend to shareholders then the investors are not willing to invest their money on the company assets. Or it may reduce the earning capacity of shareholders.

·         It affects the goodwill of a company and due to that the market position of a company is reduces.

Over capitalisation: In over capitalisation the company hold more capital than needed for business operation. It is also not good for the business because:

·         The excess capital kept ideal in a company. It acts as wastage of economic resources.

·         The extra funds spend on holding that excess capital in a company.

·         The interest or dividend is paid on that excess capital which reduces the profitability of a company.

·         The excess capital is used for speculation purpose.

But sometimes company uses conservative strategy which considers over capitalisation, in which the excess funds are kept in a business:

·         To meet an uncertain future events by maintaining reserves like paying dividend to shareholders at the time when there is no enough profit in a company.

·         The excess funds are used for investment and expansion purpose like purchasing a new building for new branch, purchasing a new technology machines to stay updated in a market.

Watered capitalisation: Under this capitalisation the book value is more than the real value of assets in a company. It occurred at the time of incorporation of a company. It is also not good for the business because:

·         Company pay more than actual value of assets.

·         Those excess funds that company paid are acts as wastage for company.