Is your firm Over Capitalized?

Under capitalization and over capitalization are both very common in businesses in SME sector in the
Middle East. Though both are equally dangerous for the company over capitalization poses a severe threat.

Over-Capitalization is the situation in which the firm has more capital than required. In other words assets are worth less than the capital.

The main causes for
Over-Capitalization are:

1. Over-Capitalization
capital arises when the there is a capital or debentures more than what company
can employ profitably.

2. The rate at which the
borrowing has been made is higher than that of the company’s earning potential.

3. Sometimes it may arise due
to improper provision for depreciation and replacement of assets or distribution
of dividends at a higher rate.

4. The excess payment for
fictitious assets acquisition like goodwill, etc can also be a cause.

5. Even improper estimation
and capitalization also contribute to Over- Capitalization.

The Over-Capitalization
leads to reduction in rate of interest and dividend and thus even market price
of the share may decline. The tendency of window- dressing and profit by book
adjustment can also be an effect of Over-Capitalization. In extreme case it
will even lead to re-organization or re-construction and sometimes to
liquidation.

In order to overcome
Over-Capitalization the main techniques adopted by the company are
re-organization, buyback, reduction in claim of the creditors and debenture
holders and also the reducing of the shares.

With expansion policies in
mind there are many companies in the region are borrowing at a higher cost than
they can generate from the business. Also companies are in the craze for buying
another companies paying huge goodwill. If those tendencies are not monitored
efficiently then the problem of Over-Capitalization can also be at your
doorstep soon.

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