What do you mean by capitalization?


What do you mean by capitalization?

The term ‘capitalization’ is used in quantitative aspect and refers to the amount at which a company’s business can he valued. The term, actually, has been used by different authors in a variety of senses in the literature of financial management. Some authors have used the term in broader sense while others in narrow sense. In a broader sense, the term capitalization has been used in the sense of financial planning. It means, it includes the amount of capital to be raised, the securities through which it is to be raised and the relative proportion of different classes of securities to be issued and the administration of capital. The analysis of this interpretation shows that it is nothing less than financial planning.

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In the narrow sense of the term ‘capitalization’ means the amount at which a company’s business can be valued. The traditional authors define the term in this sense. This interpretation of the term is more specific though restricted, it is in this sense that the term is used here. Dewing takes it to mean the sum total of the par value of all shares. In business it refers to either of the following views:

  • The total par value of all the securities i.e., shares and debentures- outstanding at a given time and surplus in whatever form it may appear; or
  • The total par value of all securities at a given time and valuation of all other long-term obligation plus surplus in whatever form it may appear.

A few definitions of capitalization are being reproduced below in order to understand the term well:

  • According to Gerstenbergh, “For al practical  purposes, capitalization means the total accounting value of all the capital regularly employed in the business.”
  • According to A.S. Dewing, “The term capitalization, or the valuation of the capital includes the capital stock and debts.”

The essence of the above definitions is that capitalization is the sum total of all long term securities issued by a company and the surplus not meant for distribution. Thus it comprises:

  • The value of shares of different classes i.e. ordinary shares and preference shares.
  • The value of all surplus whether earned surpluses or capital surpluses, which are not meant for distribution.
  • The value, of bonds and securities issued by a company still not redeemed.
  • The value of long-term loans secured by the company other than bonds and securities such as loans taken from financial institutions.

The earned surpluses mean undistributed profits accumulated over a period of time in the form of reserves and meant for utilizing them to meet the company’s long-term requirement. Capital surpluses mean all other reserves except earned surpluses.

According to few, the problem of capitalization arises only at the time of promotion of a company. But it is not so. The problem of capitalization may arise, at any time after the promotion and during the lifetime of the corporation. Centrally, the problem of capitalization arises in the following circumstances:

  • At the time of corporation of a company.
  • At the time of expansion  of the existing corporation.
  • At the time of recapitalization and re-organisation of capital, and
  • At the time of amalgamation and absorption of two concerns.

Capitalization refers only to the par value of the long-term securities i.e., shares and debentures issued by the company plus reserves and surpluses (capital or revenue) not meant for distribution among the shareholders and meant to be used to meet the long term and permanent needs of the concern, Capital includes all the loans (whether due to owners or to outsiders or whether long-term or short term) and reserves of the concern, whereas ‘capitalization’ includes only long term loans and retained profits besides the share capital.

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