Capitalization in business finance

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Capitalization meanings:

Capitalization refers to the amount of capital required by the business enterprise. The capital may be obtained:

(a) by issue of equity and preference shares,
(b) by issue of debentures,
(c) by obtaining loans, and
(d) by retained earning.

Thus capitalization is the sum total of funds received through shares, bonds, loans and retained earnings. In other words, the sum total of fixed capital and working capital forms capitalization.

Definitions of capitalization


1. A. S. Dewing. “The term capitalization or the valuation of capital includes the capital stock and debt”.

2. Gestenbergh. “For all practical purposes, capitalization means the total accounting value of all the capital regularly employed in the business.”

While determining the capital of a company, the promoter must take into consideration the cost of fixed assets, cost of establishing, organizing and running the business, working capital and sufficient funds to meet contingency demand.

The term capitalization is closely associated with the earning capacity of the enterprise. Both over-capitalization and under-capitalization are dangerous for the organization. A stage of optimum capitalization is the desired goal of every enterprise. It is a stage, where the company earns a fairly good return.

The term capitalization means all long term funds raised through issue of shares, debentures and loans from specialized financial institutions.

Example

A company has the following information at the liabilities side of the balance sheet:

$
Equity share capital40,00,000
Preference share capital10,00,000
Debentures20,00,000
Loan from IBRD25,00,000
Loan from IFC15,00,000
Creditors5,00,000
Outstanding20,000

Capitalization, in this case, will amount the sum total of long term funds, i.e., equity share capital, preference share capital, debentures, loan from IBRD and IFC, It may now be summed up that capitalization in a broader sense refers to the process of determining the plan or patterns of financing.

In narrower sense capitalization is the sum total of all long-term securities issued by a company and the surpluses not meant for distribution. It should also be noted that the term capitalization is used only for companies and not in respect and sole proprietorship. Capitalization is capital plus long term loans and retained earnings.

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