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Capitalization (2).pptx

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Capitalization (2).pptx

  1. 1. Capitalization
  2. 2. Meaning/ Definition  General sense- It is related to total amount invested in business.  Broad sense- It means forecasting the need of funds for company, their sources and the proportion of such sources.  Narrow sense- This refers to the process by which a firm determines the quantum of long term requirement of funds.  Modern sense –The narrow interpretation of term capitalization is widely accepted since it is very specific in the meaning. However, in the modern concept, not only the long term funds but also the short term funds are included in capitalization.
  3. 3. Definition  “Capitalization means that amount of capital which is represented by the total shares held by shareholders and the issued debentures and bonds.”  According to the modern concept, not only the long-term capital but also the short term capital is included in capitalization.
  4. 4. Situations of Capitalization Fair Capitalization Over-Capitalization Under-Capitalization
  5. 5. Over-capitalization  When the amount of capitalization of a company is greater as compared to its average income.  When the firm unable to get a fair return on its capital.  When the firm is unable to distribute a fair dividend to its shareholders.  It is said to be over-capitalized
  6. 6. Over-capitalization (Cont’d)  “When a company has consistently been unable to earn fair return on the amount of shares and debentures that have been issued than it is said to be Over-capitalized.”  So when a company is unable to earn sufficient profits on its capital employed & the real value of its total assets is less than its book value  Real Value of Total Assets < Book Value ofTotal Assets
  7. 7. Values of shares Par Value of shares • It means face value of the shares which is mentioned in MOA Market Value of shares • It means that value of shares which is mentioned in the stock exchange. • It is affected by internal & external factors Book Value of the shares • It is the price which we get by dividing the sum of share capital & reserves and surplus with the number of shares issued Real Value of shares • It is calculated by dividing the capitalized value of assets with the number of shares issued • Capitalized value = Avg. Annual income / Capitalization rate • Real Value of shares= Capitalized value / number of shares issued
  8. 8.  The balance sheet of XYZ ltd as on 31-12-2010 is given below. If Avg. annual earnings of company are Rs 18,000 & if required rate of return is 12 %. Calculate Par value, Book Value, market value & real value. Example Liabilities Amount Assets Amount Share Capital(Paid Up) Sundry Assets 2,70,000 15,000 shares @ 10 Rs Each 1,50,000 Reserve & Surplus 75,000 Sundry Liabilities 45,000 Total 2,70,000 Total 2,70,000
  9. 9. Solution  Par Value of shares = Rs.10 per share  Book Value = 1,50,000 + 75,000 15,000 = Rs 15 per share  Market Value = Opening Price + Closing Price 2  Real Value :-- Capitalized value = 18,000 = 1,50,000 12%  Real Value = 1,50,000 15000 = Rs. 10 per share
  10. 10. Causes of Over-Capitalization Over-Issue of capital Over-estimations of earnings at the time of promotion Expansion or promotion of the company during boom period Liberal Dividend Policy Shortage of capital High promotion expenses
  11. 11. Consequences of Over- Capitalization Effects on Society • Loss to consumers • Loss to workers • Misutilization of society’s resources • It also leads to recession in the economy
  12. 12. Consequences of Over- Capitalization Effects on Company Adverse impact on goodwill of company Difficulty is raising additional funds Decline in efficiency of the company Difficulty in the payment of interest Manipulation of accounts to show inflated profits
  13. 13. Consequences of Over- Capitalization Effects on Shareholders Due to lower earnings shareholders get lower dividend Adverse impact on market value of shares. Unacceptable as collateral security
  14. 14. Remedies for Over- Capitalization Reduction in long-term debt Reduction in the rate of Interest on debentures Redemption of high dividend preferred stock Ploughing back of profits
  15. 15. Under-Capitalization  It is the situation when a company is continuously earning abnormally high profits on its capital employed.  In this Market value of the share is higher than its BookValue  It signifies that the assets of the company are being utilized more efficiently  It is the situation when the average income of company is greater as compared to the amount of capitalization & such company declares dividend at a higher rate.
  16. 16. Causes of Under-Capitalization Under- estimation of Earnings Promotion of company with deflated assets Conservative dividend policy Under estimations of capital requirements Low promotion expenses
  17. 17. Effects of Under-Capitalization Effects on the Company • It helps in increasing the competition in the market. • Firms have to pay higher taxes on higher incomes. • Due to high profits the workers can demand for more wages and bonus. • It leads to the possibility of government interference due to high profits
  18. 18. Effects of Under-Capitalization • They can earn high rate of dividend • It also increases Market value of share which leads to speculation in the market • Due to high goodwill the shareholders can easily raise loan on the security of shares. Effects on Shareholders
  19. 19. Effects of Under-Capitalization on society It encourages new entrepreneurs to establish new businesses Consumers can get better quality of products at fair prices It generates employment in society It creates capital formation in the country
  20. 20. Remedies for Under-Capitalization Issue of Bonus shares Splitting of shares Issue of fresh shares

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