Capitalization Question:

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(ii) Under capitalization can also cause companies to use their old and out of date equipment because of inability to buy new items or purchase new items.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