FINANCIAL MANAGEMENT
It is related to total amount invested in business.
General Sense
It means forecasting the need of funds for company, their sources and the proportion of such sources.
Broad Sense
This refers to the process by which a firm determines the quantum of long term requirement of funds.
Narrow 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.
Modern Sense
means that amount of capital which is represented by the total shares held by shareholders and the issued debentures and bonds.
Capitalization
not only the long-term capital but also the short term capital is included in capitalization.
Modern Concept
(also known as the par value) is the nominal value assigned to each share and is mentioned in the MOA. It is the value at which shares are issued and recorded on the company's balance sheet.
Face Value
The capital clause in the MOA specifies the total authorized capital of the company and the division of that capital into shares of a fixed face value.
Capital Clause in Moa
is a legal document that outlines the foundational aspects of a company. It includes key details that are critical for understanding the company’s structure, scope, and operations.
Memorandum of Association
Specifies the name of the company.
Name Clause
States the location of the company's registered office.
Registered Office Clause
Indicates the extent of liability of the company’s members (limited or unlimited).
Liability Clause
Defines the main objectives and activities of the company.
Object Clause
Details the company's authorized share capital and the face value of the shares.
Capital Clause
refers to a situation where a company has issued more capital (in the form of shares and debentures) than it can effectively use to generate a reasonable return.
Over capitalization
When a company issues more shares than necessary, it dilutes earnings per share (EPS) and may not be able to achieve a satisfactory return on the capital invested.
Excessive Issuance of Shares
Issuing too many debentures or other forms of debt can lead to high interest expenses that exceed the company's earnings, resulting in financial strain.
High Level of Debt
If assets are overvalued on the balance sheet, it may lead to over-capitalization if the returns generated from those assets do not justify their recorded value.
Overvaluation
Poor investment decisions or inefficient management can result in returns that are insufficient to cover the capital costs.
Inefficient use of Capital
The company struggles to generate returns that justify the high levels of capital. This is often reflected in lower profitability ratios and reduced return on equity (ROE) or return on assets (ROA).
Low Returns
With excessive capital, the cost of servicing debt and providing dividends to shareholders may become unsustainable.
High Cost of Capital
If returns are consistently low, shareholder value is negatively impacted, potentially leading to lower stock prices and reduced investor confidence.
Reduced Shareholder Value
The company might face difficulties in meeting its financial obligations, including interest payments and dividends, leading to potential liquidity problems.
Financial Strain
Ratios such as return on equity (ROE), return on assets (ROA), and interest coverage ratios can help detect over-capitalization. Consistently low returns or high interest expenses relative to earnings are red flags.
Financial Ratios
Measure a company's ability to meet its short-term obligations.
Liquidity Ratios
Assess a company's ability to generate profit relative to its revenue, assets, or equity.
Profitability Ratios
Evaluate a company's long-term stability and its ability to meet long-term obligations.
Solvency Ratios
Indicate how well a company uses its assets and liabilities to generate sales and maximize profits.
Efficiency Ratios
Relate a company's stock price to its financial performance.
Market Ratios
Comparing the company’s capital structure and returns with industry standards or similar companies can highlight potential over-capitalization issues.
Comparison with Industry Peers
The company might need to reduce its capital base through methods such as share buybacks or debt restructuring to align its capital structure with its actual earning capacity.
Capital Restructuring
Enhancing operational efficiency, better investment decisions, and cost control can help in generating higher returns on the existing capital.
Improving Efficiency
Reducing high levels of debt can decrease interest expenses and improve profitability.
Debt Reduction
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.
Under capitalization