Capitalisation

The assessment of the funds needed by the company should be done in such a way that the total amount of funds available be neither too large not too less. As such, one of the most important financial decisions becomes the determination of the amount which the company should have its disposal (which may consist of funds required for fixed assets as well as the portion of current assets to be financed by the company out of long term sources). This is capitalisation.

Thus the term capitalisation means total amount of long term funds available to the company. In the words of Dewing “Capitalisation includes capital stock and debt”. Therefore capitalisation includes the shares and debentures issued by the company and also the long term loans taken from the financial institutions. The question arises regarding the inclusion of non-distributed profit in the capitalisation.

As far as earned profits remained to be distributed (i.e. reserves and surplus) are concerned; it is necessary to classify them as either capital surplues or revenue surplues. Capital surplus will always be a part of total capitalisation, though it is available for cash dividend under certain circumstances. Revenue surplus will be a part of capitalisation of the maangement wants to retain it in the business.

The importance of the determination of amount of capitalisation need not be over emphasised. The amount of capitalisation should be only that much which can be justified by its profits by the normal rate of return for the industry concerned. If the company earns less than the other companies in the same industry, value of the shares of company will reduce and the company will suffer.

For example, if the company earns an after tax profit of $ 20 lakhs and the other companies in the same industry earn after tax return of 10% on their capitalisation, the expectation of investors will be the same from company. As such, the ideal capitalisation for the companies will be $ 200 lakhs. If the actual capitalisation is $ 250 lakhs, the after tax return for the company becomes 8% which is less than industries standards. As a result, price of the shares of the company will be less than that of other companies in the same industry.

For more help in Capitalisation homework assignments please click the below button to submit your homework requirements