Capitalization Interview Preparation Guide

- Watered capital is called so because the flow of money can be seen at the time of promotional events only and then money flows like water with the capital in the initial period at the time of promotion whereas Over capitalisation can be calculated after the company has worked for some years and at the end only.

- Over capitalization can be caused by watered capital whereas water capital is not caused by overcapitalization and it can be calculated at the time when the company is taking the promotional event in hand.

Watered stock/capital is that stock which is issued with a value much higher than the value of assets which a company own. It can be caused by excessing stock dividends, overvalued assets and large operating losses. The assets can have these features including values which are directly related to accounts or through excessive issue of stock. It is an asset with an inflated value which is not real but has the artificial significance. The reasons which lead to this situation are the excess price of paid for an asset. For example if a company pays 25,000 on account of goodwill, which if valued Rs. 20,000 then the capital which is watered to the extent of Rs. 2,000. During the time of promotional activities water enters the capital in the initial period of time.

- Overcapitalization is a state where earnings are not sufficient to justify the fair return on the amount of share capital which has been issued by the company whereas undercapitalization is a state where the capital which is owned by the business is much less than the borrowed capital.

- Overcapitalization happens when the actual profits of a company are not enough or sufficient to pay interest to the creditors whereas undercapitalization happens due to over-trading and when the company earn high profits as compared to other industry.

- Overcapitalization shows the rate of return as declining entity whereas undercapitalization shows the rate of return as increasing entity.

Capitalization is a collection of share capital, loans, reserves and debentures. It represents permanent investment in companies and it also removes the need of long-term loan plans. It is used to show the reality of the industry by promoting competition, development, profit and investment between individuals, companies and businesses. Balance capitalization is part of this Capitalization only where it is compared to the relative importance, value and other things to make it proportionate in every sense. In balance capitalization debits and credits should be equal on both sides and the share should be shared among all in equal proportions.

Remedies are the solutions which are available for the companies to overcome the problem of undercapitalization this can be done by using two factors. These factors are as follows:-

1) Splitting up the shares will reduce the dividend per share and don’t give more to one only but equally to everyone and the high earning can be utilized properly.

2) Issue bonus shares to the company members who are currently associated with the company as well as the shareholders stake by doing this both the dividend per share and earnings per share will reduce.

a.) Company

The under capitalization in this one effect the company to bring the greater reputation for them and with greater earning their market shares also increases. Higher rate of earning also allow higher competition in the market. The demand of workers to do good quality product also rises due to flow of high profits.

b.) Shareholders

The effect of under capitalization on the company is much more as the company's profits increases as the earning goes up but the market value goes down due to increase of share rise company’s profitability increases. As a result, rate of earnings go up. The financial reputation also increases due to having capital in the hands of the company. In the company in this situation the shareholders can also enjoy high dividend due to raise in profits and saving of money.

c.) Consumers

This situation affects consumer by having their interest getting affected as they think that company is over charging them on the products as the company is having high probability of raising more profits by doing their bit. So, consumers here are on the receiving end as they have to pay up more to buy a product which has cost included of marketing and advertisements and other promotional agendas.

d.) Society

Society is getting affected by the high earning and high profitability and high market price of shares and there can be unhealthy talks in stock market about the company which is having all these with them. Generally public expect high prices of product from high profits of a particular company. Company also maintains stock to keep the money secretly which allow them to pay lower taxes to the government. Public also raises the high expectations from the companies which got high profits to raise the innovation bar and to provide good facility and high end technology of the product in the market.

Undercapitalization is when the actual capitalization is lower than its proper capitalization as it is given by its earning capacity. Undercapitalization is indicated by the condition above and when the rate of earning is very high in effect to the returns which other companies get which are in the same industry as others. This is also indicated when a company does not have sufficient capital to conduct normal business operations and they have to pay the people from whom they have taken. When a company doesn't generate enough cash flow to access the forms then it is said to be undercapitalized.

a.) Company

(i) It has a big impact on the company because of low profits the companies reputation is harmed.

(ii) The promotion of the company because difficult to do and the shares of the company can't be easily marketed.

(iii) Borrowings from other parties become hard due to decline of earnings by the company and due to this the reputation of the company goes down which in turn makes the company looses its credibility.

(iv) Company indulge in malpractices to retain its image for example manipulation of accounts to show high earnings.

(v) Company under the influence of low capital cuts down the expenditure on maintenance, replacement of assets and do the necessary cost cutting for example removal of the stuff etc.

b.) Shareholders

As the companies profit decreases the rate of earning of shareholders also decreases as they both are directly proportional to each other. Due to this problem only the market price of the share also go down. Due to over capitalization the shareholders positions become uncertain and their profits or earnings also been cut down. Share value also decreases and they can't be marketed correctly.

c.) Consumers

Consumers are the people who are buying the company shares so to cover up the companies earning the management indulges in wrong doing to increase or decrease the capital in quality on the paper. Return on the capital becomes low which gives the impression to the customer that the resource which company is using is not utilized in a right manner. Consumer starts questioning the credibility of the company due to their low earnings as the company fail to pay its creditors on time. It also has an effect on working conditions and payment of wages and salaries also lessen.

d.) Society

It has an effect on the society by speculating about the company which are under-performing and those people who buy the shares always remain in panic as what will happen to their investments which they have done. It has also an effect on working conditions and payment of the group of people working in the company which are going through this phase. The salaries of other groups in the companies also lessen down due to this.

There are different sorts of remedies available for over capitalization which are as follows:-

1) The company can overcome Over-capitalization by reducing its capital so as to obtain a satisfactory relationship between proprietors’ funds and net profit.

2) The company can overcome this phase by spending the money wisely and in those areas where they can get some profits.

3) The company can also overcome this by utilizing the money which has been idle in the bank and put up in some investment and has not been used till now.

4) The company can also overcome this by removing the over-valuation policy by bringing down the values of assets to their proper values.

Company may have funds which might not have been used properly e.g. Money invested in such projects that are giving very low profits.