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Under Capitalization Definition And Meaning

Under Capitalization:

Under capitalization is the opposite concept of over capitalization and it will occur when the company’s actual capitalization is lower than the capitalization as warranted by its earning capacity. Under capitalization is not the so called inadequate capital.

Under capitalization can be defined by Gerstenberg, “a corporation may be under capitalized when the rate of profit is exceptionally high in the same industry”.

Hoagland defined under capitalization as “an excess of true assets value over the aggregate of stocks and bonds outstanding”.

Causes of Under Capitalization:

Under capitalization arises due to the following important causes:

• Under estimation of capital requirements.

• Under estimation of initial and future earnings.

• Maintaining high standards of efficiency.

• Conservative dividend policy.

• Desire of control and trading on equity.

[Post Image Courtesy of StockImages at FreeDigitalPhotos.net]

Effects of Under Capitalization:

Under Capitalization leads certain effects in the company and its shareholders.

• It leads to manipulate the market value of shares.

• It increases the marketability of the shares.

• It may lead to more government control and higher taxation.

• Consumers feel that they are exploited by the company.

• It leads to high competition.

Remedies of Under Capitalization:

Under Capitalization may be corrected by taking the following remedial measures:

1. Under capitalization can be compensated with the help of fresh issue of shares.

2. Increasing the par value of share may help to reduce under capitalization.

3. Under capitalization may be corrected by the issue of bonus shares to the existing shareholders.

4. Reducing the dividend per share by way of splitting up of shares.

About Author Mohamed Abu 'l-Gharaniq

when an unknown printer took a galley of type and scrambled it to make a type specimen book. It has survived not only five centuries.

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