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What is capitalization? What is its importance?

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posted Jun 21 by Tanmay

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Capitalization is a term which has different meanings in both financial and accounting context. Capitalization in accounting means the cost to buy an asset which is included in the price of the asset whereas in financial terms it is the cost which is required to buy an asset which includes price of a particular asset and it also include the retained earnings of a company with stock debt and long term debt. There are two kinds of capitalization which are called as Over-capitalization and another is called as Under-capitalization. Capitalization is very import aspect in determining the value of the company in the market which is based on the economic structure of the company. This aspect depends on the previous records and economics of the company. This also shows a particular behaviour of the companies’ structure and allows them to create a plan to do the marketing.
The objective of every business is to maximize the value of the business. In this respect the finance manager, as well as individual investors, want to know the value created by the business. The value of business relates to the capitalization of the business.

The need for capitalization arises in all the phases of a firm’s business cycle. Virtually capitalization is one of the most important areas of financial man­agement. In this article we will discuss various aspects relating to capitalization.

Concept of Capitalization:

Capitalization refers to the valuation of the total business. It is the sum total of owned capital and bor­rowed capital. Thus it is nothing but the valuation of long-term funds invested in the business. It refers to the way in which its long-term obligations are distributed between different classes of both owners and creditors. In a broader sense it means the total fund invested in the business and includes owner’s funds, bor­rowed funds, long term loans, any other surplus earning, etc. Symbolically:

Capitalization = Share Capital + Debenture + Long term borrowing + Reserve + Surplus earnings.

Different authors have defined capitalization in different ways but the theme of those definitions remains almost same. Some of the important definitions are presented below:

According to Guthmami and Dougall, ‘capitalization is the sum of the par value of the outstanding stocks and the bonds’.

In the words of Walker and Baughen, ‘capitalization refers only to long-term debt and capital stock, and short-term creditors do not constitute suppliers of capital, is erroneous. In reality, total capital is furnished by short-term creditors and long-term creditors’.

Bonneville and Deway define capitalization as ‘the balance sheet values of stocks and bonds outstanding’.

answer Jun 22 by Deepak Jangid
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