Under-Capitalization

Under-Capitalization -Under-capitalization is just the reverse of over-capitalization. Sometimes a company, on the face of it, may have an insufficient capital but it may have large secret reservesThus, in case of well-established companies, there is a very large appreciation in the value of assets specially of buildings, plant and goodwill. Such appreciation is generally not brought into the books. Nevertheless these assets do bring profits and, therefor, the profits in such a company would appear to be much larger than are warranted by the book figures of the capital. In such a case, the dividends will be high and the market quotations of the shares of such companies will be higher than the par value of the shares of other similar companies. It is in this sense that an under-capitalized company pays high rates of dividend and the value of the shares is higher than the par value. A company is under-capitalized when its actual capitalization (i.e., total long-term resources) is lower than its proper capitalization as warranted by its earning capacity. Such a company will earn considerable more than the prevailing rate on its outstanding securities.

The possible corrections for under-capitalisation may be outlined as under:

             (i)Splitting-up of shares.
(ii) Increase in par value of shares. 
(iii) Issue of bonus shares.

Disadvantages of Under-Capitalization

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