INTRODUCTION

A.S. Dewing says, “the term capitalisation or the valuation of capital includes the capital
stock and debt.”1 Attention is focused on the quantitative aspect only. In this sense, it includes
ownership capital and the borrowed capital as represented by long-term indebtedness. Surplus in
the business in the form of free reserves is also considered as an integral and expected part of
capitalisation.

There are three ingredients of capitalisation:

1. The value of all kinds of shares.

2. The value of bonds outstanding.

3. The value of surpluses-capital or earned surpluses not meant for distribution.

In the formulation of a financial plan of a corporation, we have to make the decision relating to
the total amount of securities to be issued. Capitalisation indicates the total par value of the
outstanding amount of securities in the form of share capital, debenture capital and the face value
of other long-term obligations. Short-term loans or temporary bank loans are usually excluded
from the capitalisation.

Capitalisation = Ownership capital + long-term loan capital = Share capital + free reserves +
debenture capital + long-term loans 2.

The capital structure of a company should be fair, neither overcapitalized, nor undercapitalized.
The availability of funds should be neither too much nor too low.

OVER- CAPITALIZATION:

A company is said to be over-capitalized when its earnings are not sufficient to justify a fair return
on the amount of capital raised through equity and debentures. 3

1
https://www.businessmanagementideas.com/essays/essay-on-capitalisation-meaning-theories-and-types/4562.
2
Ibid.
3
https://www.academia.edu/35540977/Over_Capitalization_and_Under_Capitalization_of_Company.
It is said to be over capitalized when the total of owned and borrowed capital exceeds its fixed and
current assets. This happens when it shows accumulated losses on the assets side of the balance
sheet.

An over capitalized company is like a bulky person who is not able to carry his weight properly.
Such a person is prone to many diseases and is definitely not likely to be requisite active life.
Unless the condition of overcapitalization is rectified, the company may suffer from many
difficulties.

Causes of Over Capitalization 4:

The important reasons of over-capitalization are:

1. Idle funds:

The company may have unused funds lying idle in banks or in the form of low yield investments,
and there is no likelihood of using it properly in the near future.

2. Over-valuation of acquired assets:

The fixed assets, particularly goodwill, might have been bought at a much higher cost than
warranted by the services to be rendered.

3. Fall in value of fixed assets:

Fixed assets might have been acquired at a time when prices were high and now the prices have
corrected substantially. But in the balance sheet the assets are yet shown at their book value less
depreciation written off.

4. Inadequate depreciation provision:

If proper and adequate depreciation has not been provided on the fixed assets the result would be
more profits in the Profit & Loss Account. This book profit might have been distributed as dividend
and leaving no funds with which to replace the assets at the right time.

4
https://www.academia.edu/35540977/Over_Capitalization_and_Under_Capitalization_of_Company.
Effects of Over-Capitalisation:

(A) Effects on the Company:

1. Low dividend rates,

2. Low market price of shares and loss of investors confidence5.

3. Manipulation of accounts to show prosperity on paper.

4. Inadequate provision for depreciation, replacement and reserves.

(B) Effects on the Shareholders:

1. Depreciation in share value.

2. Low, uncertain and irregular income.

3. Low loan value of shares.

4. Unhealthy speculation and exploitation of real investors6.

5. Reduction and re-organisation of capital-burden on shareholders.

(C) Effects on Society:

When a company is over-capitalized, it tries to increase the prices and reduce the quality of
products. But to adopt both these practices, company has to face one great difficulty and there is
keen competition in the market. The result is that sooner or later the concern may have to face
liquidation.

Panic may be created due to failure of such an over-capitalized concern. Members lose on both
fronts due to lower dividends — on lower share prices in the market. Not only are the creditors of
the company adversely affected but the workers also lose their employment.

5
https://www.yourarticlelibrary.com/financial-management/types-of-capitalization-over-and-under-capitalization-
financial-management/29394.
6
http://jrajeshfm.blogspot.com/2017/04/what-is-capitalization-what-are-kinds.html.
Abad ethical atmosphere is created in the society and the whole economy may suffer from
depressing effect. An over-capitalized company likes to effect economy by wage cuts and it may
have to face strikes and labour unrest.

Over-capitalisation also leads to wastage and mis-application of scarce financial resources of the
society. The cure for an over-capitalized company is reorganization of capital structure, if
necessary, with reduction of share capital. Otherwise, sooner or later, the corporation may have to
face insolvency and liquidation.

Remedies of over-capitalization:

The process of remedying overcapitalization is very painful. It can be remedied through following
measures:

1. Reduction in its capital so as to obtain a satisfactory relationship between proprietary funds and
net profit.

2. If over-capitalization is because of result of over-valuation of assets then it can be remedied by

bringing down the values of assets to their proper values.

3. Reduction of debt burden. For which negotiations with the big lenders may be made to reduce
the interest obligation.

4. Preference shares may be redeemed through capital reduction scheme.

5. Reducing face value and paid up value of equity shares.

6. Initiating merger with well managed profit making companies interested in taking over ailing
company.

Many Indian companies have resorted to remedying overcapitalization through the measures
mentioned above.7

UNDER CAPITALIZATION

7
https://www.academia.edu/35540977/Over_Capitalization_and_Under_Capitalization_of_Company.
The phrase ‘Under-capitalisation’ should never be misconstrued with inadequacy of capital. Truly
speaking, this term is used to denote the state of affairs just converse of over-capitalisation8.

Under-capitalisation may be preferred in those cases where there is genuine rise in earnings, better
financial planning and efficient management. The rate of dividend will be very high and the market
price of the shares will also be very high. But this situation also leads to certain evil consequences.

When a company succeeds in earning abnormally large income consistently for a pretty long time,
symptoms of under-capitalisation gradually develop in the company; the most important one being
that market value of shares of the company exceeds their book value. Under-capitalisation is an
index of effective and proper utilisation of funds employed in the enterprise.

Where under-capitalisation arises from shortage of funds, it may lead to some serious
consequences. Firstly, since there is inadequacy of capital there will be constant danger of failure
of the company. It may not be able to pay its creditors in time. This will spoil the credit worthiness
and reputation of the company. Secondly, it has to go in for loans at higher rate of interest to make
up the deficiency of share capital.

It should be noted in this regard that if a company under exceptionally good conditions makes
substantially large earnings in a year or so, it should not be considered that the company is under-
capitalized. Over-capitalised concerns have always earning superiority over average concerns
engaged in the same line of activity.

Thus, under-capitalisation is indicative of sound financial health and good management of the
company. Bonneville and Dewey rightly observed that “Under-capitalisation is not an economic
problem but a problem in adjusting the capital structure” 9.

Causes of Under-Capitalisation:

(1) Deflationary Condition10:

8
https://www.slideshare.net/umeshutage/capitalisation-69712195
9
Supra 1.
10
Ibid.
Companies set up in recessionary condition generally become under-capitalized after recession is
over. There are two factors contributing to this tendency. In the first instance, during recession
assets are purchased at exceptionally low prices which bear no relation with their income
producing capacity. As period of recession abates, earning position of the companies tends to
improve.

This would result in increase in real value of assets while book value of assets remains as before
and the consequence would be under-capitalisation. Secondly, companies set up in period of
recession are capitalized at low figure anticipating low level of business income. But as the period
of recession is over, company’s earning capacity improves and the result is undercapitalization.

(2) Conservative Dividend Policy:

Company following conservative dividend policy builds up substantially large funds available for
replacement and renovation of obsolete assets and for financing developmental and expansion
purposes. This thus goes a long way in improving earning position of the company.

(3) Maintaining High Standards of Efficiency:

By employing new techniques of production and rationalization of production activities, operating

efficiency of a company can be improved.

(4) Under-Estimation of Initial Earnings

If earnings of new venture were under-estimated and the enterprise was capitalized accordingly, it
may find itself in condition of under-capitalisation afterwards when it’s actual earning was much
more than what was anticipated.

(5) Using Low Capitalisation Rate11:

If low capitalisation rate was employed to determine capitalisation of a company, it might plunge
in state of under-capitalisation subsequently when it would be found that actual capitalisation rate
was much higher than the employed one.

11
https://www.slideshare.net/umeshutage/capitalisation-69712195.
Consequences of Under-capitalisation12:

On Company:

Although under-capitalisation does not threaten financial stability and solvency of the enterprise,
management should not be complacent towards this situation because the company may suffer in
the following ways:

On Society:

Under-capitalisation does not pose any economic problem to the society. On the contrary, it may
prove boon to it. It encourages new entrepreneurs to set-up new ventures and encourages the
existing ones to expand. This as a result, boosts industrial production. Consumers get variety of
products at relatively cheaper rate.

Establishment of more and more firms and expansion of existing ones helps to mitigate sufferings
of unemployed persons. Purchasing power of newly employed people increases resulting in a rise
in demand which, in turn leads to increase in investment and production. Through demand-
investment and employment spiral the economy marches ahead to reach the pinnacle of prosperity.

However, society may plunge in state of turmoil when psychic feeling develops among consumers
and workers that they are being plundered by capitalists. This feeling may sow seeds of dissension
among consumers at large and labour-management relation is disrupted.

The whole society is mired in plight of discontentment and agitation forcing government to
intervene immediately and to clamp, for that matter, numerous types of controls such as price
control, dividend ceiling and dividend freeze.

On Share-Holders:

Under-capitalisation is advantageous to shareholders in as much as they get high dividend income

regularly. Because of soaring rise in share price of under-capitalized concerns, shareholders’
investment in these companies appreciates phenomenally which they may encash at any time.

12
https://cleartax.in/s/corporate-restructuring.
In another way also, under-capitalisation benefits the shareholders. They can, in periods of
necessity, get loans on soft-terms against the security of their shares because of high credit standing
of the under-capitalized concerns in the market.

Remedies for Under-Capitalisation:

To correct condition of under-capitalisation it is inevitable on the part of the company to reorganize

its capital structure in such a way that number of shares increases and earning per share is reduced.

(1) Splitting Stock13:

Another effective way of reorganizing capitalisation of a company to reduce the effects of under-
capitalisation is to split up the stock into a large number of shares and reduce the value of each
share in accordance with the rate of split up. The effect of this split is that the earnings would be
spread over a greater number of shares, Supposing a company is capitalized with Rs. 1,00,000
divided into 1000, its earning per share would come to Rs. 10.

Management may reduce earning per share if it so likes by taking recourse to stock split. If, for
example, the management decides to reduce par value of shares by 50 percent and increase the
number of shares in the same proportion, number of shares in the company would after splitting
double to reach 20,000 shares and earning per share would be halved to Rs. 5.

The shareholders will have no objection to this procedure because they are not going to lose
anything. Thus, by this simple device the management can neutralize the effects of under-
capitalisation and save the company from any eventuality.

It is evident from the foregoing discussions that both the strategy under-capitalisation and over-
capitalisation are undesirable and should be discouraged as far as possible. Over-capitalisation
means a great strain on the financial structure of a company, an evil for shareholders and a menace
to economic prosperity, and stability of society.

On the other hand, under-capitalisation encourages competition on the part of business rivals, sows
seeds of dissension among labourers and creates psychic feeling of being exploited among

13
http://jrajeshfm.blogspot.com/2017/04/what-is-capitalization-what-are-kinds.html.
consumers. On comparison, state of over-capitalisation relatively is more harmful. However, the
management should avoid emergence of both these situations and its ideal should be of fair
capitalisation.

(2) Capitalisation of Surplus of the Company:

If a company has adequate surplus in hand the whole or a part of it can be capitalized by issue of
bonus shares. This will, in no way, affect the quantum of capitalisation. Of course, make-up of
capitalisation will undergo marked change. Thus, with issue of bonus shares, share capital will
increase and so also the number of shares but surplus of the company will lie reduced by the
amount of bonus shares. In consequence, earnings per share automatically are reduced. Take for
example, a company has total capitalisation of Rs. 2,00,000 comprising share capital of Rs.
1,50,000 (divide in 3,000 shares of Rs. 50 per share) and surplus of Rs. 50,000. The company’s
present earning is Rs. 60,00014.

Thus earning per share in this case comes to Rs. 20 per share. Management may save this company
against the effects of under-capitalisation by issuing bonus shares. If, for example, it is decided
that the company will issue 5,000 bonus shares of Rs. 10 each, share capital in the company will
increase from Rs. 1,50,000 to Rs. 2,00,000 and number of shares from 3,000 to 8,000 though of
course amount of total capitalisation remains unchanged.

As a result of this, earning per share which was earlier Rs. 20 would, after capitalisation, decline
to Rs. 7.50. However, owner’s income is no longer affected. They would continue to receive the
same amount of income even after recapitalization. This would keep the management free from
workers’ threats; consumers do not feel being exploited by capitalists.

EXAMPLE: RISK OF UNDERCAPITALIZATION AND STEPS TAKEN

A horrible week came to an end with the worst moment of all – Jay had to inform his employees
that he could not meet payroll that day. Instead of focusing on quoting new work, Jay had spent
this week fielding calls from angry suppliers seeking payment and tracking down his company’s

14
http://jrajeshfm.blogspot.com/2017/04/what-is-capitalization-what-are-kinds.html
own balances due from customers. His business had run out of cash. He was severely
undercapitalized.

I see this scenario played out all too often, in companies big and small across the country. The
whole world watched it unfold as General Motors and Chrysler came to the brink of financial
disaster. What enabled Ford to continue executing its business plan while General Motors and
Chrysler endured seemingly endless scrutiny, extraordinary professional fees, and months of
distraction? In a word: MONEY.

Having sufficient working capital enables a company to sail through rough seas and concentrate
on steering out of the storm rather than fighting the storm itself. It doesn’t matter how good your
product is, how many sales opportunities are around the corner or how efficient your operations
are if you can’t pay your bills. That’s right – if you can’t pay your bills, it’s all for naught.

Having capital is as important as having a keen grasp on every other of business management that
inspires an entrepreneur to go into business and succeed.

The first step in establishing capital is to know how much you will need. A good business plan
will address the capital need conservatively. It’s important to have contingency reserves because
Murphy’s Law is very real – if something bad can happen, it usually will. There are many resources
that provide assistance with a business plan including State and County Agencies that do this at
no cost or low cost. You may want to check out your local SBDC or SCORE office.

The next step is to approach funding sources that are appropriate to your life cycle stage and
industry. Trusted advisors, such as your accountant, attorney, mentor, as well as the above
mentioned government agencies can also help you with this. You may be asked to give up
substantial ownership, which you will have to weigh against the risk of operating with insufficient
capital, as our friend Jay did.

If you find that capital is limited, you will need to adjust your business plan to succeed on the
smaller capital base. This usually translates into slowing your growth trajectory. If you find
yourself in that position, remember that slow and steady usually wins the race.
As you build your business, keep in mind that capital is critical to making the entrepreneurial
equation work.

In order to avoid future problems with undercapitalization, entrepreneurs need to perform a

realistic assessment of their expenses and financial needs. Some of the major expenses facing a
new business include facility rental; salaries and wages; equipment and tools; supplies, utilities;
insurance; advertising; and business licenses. Based upon this information, the entrepreneur should
prepare a cash flow projection on a monthly basis for the first year. The difference between the
funds the entrepreneur is able to contribute, the amount of income the business is expected to
generate, and expenses the business is projected to incur provides a rough estimate of the business's
financial needs. Ideally, an entrepreneur will secure the necessary equity from various sources to
make up the difference and provide the business with sufficient capitalization.

OVERVIEW OF GITANJALI GEMS LIMITED15

Gitanjali Gems Ltd., incorporated in the year 1986, is a Small Cap company (having a market cap
of Rs 12.45 Crore) operating in Gems and Jewellery sector.

Gitanjali Gems Ltd. key Products/Revenue Segments include Jewellery which contributed Rs
7777.31 Crore to Sales Value (74.31 % of Total Sales) and Diamonds which contributed Rs
2687.46 Crore to Sales Value (25.68 % of Total Sales)for the year ending 31-Mar-2017.

For the quarter ended 30-09-2017, the company has reported a Standalone sales of Rs 2327.37
Crore, down -45.59 % from last quarter Sales of Rs 4277.75 Crore and up 1.68 % from last year
same quarter Sales of Rs 2288.98 Crore Company has reported net profit after tax of Rs 34.32
Crore in latest quarter.

The company’s top management includes Mr.Anil Haldipur, Mr.Dhanesh Sheth, Mr.Mehul
Choksi, Ms.Nazura Ajaney. Company has Ford Rhodes Parks & Co. LLP as its auditors. As on
31-12-2017, the company has a total of 118,616,005 shares outstanding.

15
Profile of Gitanjali Gems Limited.
Gitanjali Gems’ haywire stock 16

The stock of Gitanjali Gems has witnessed the worst monthly fall in the lifetime. Shares of
Gitanjali Gems have crashed as much as 84.73% to an all-time low of Rs 9.6 from a share price
level of Rs 62.85 (closing price on 12 February 2018) on NSE. After the day when Punjab National
Bank told about the fraud, entailing the billionaire diamantaire Nirav Modi and his uncle Mehul
Choksi (promoter of Gitanjali Gems), on 14 February, shares of Gitanjali Gems nosedived 20%
for two straight days. Considering the huge losses in the market capitalisation of Gitanjali Gems,
stock exchanges have revised the circuit limits for two times in order to trim the daily erosion. The
circuit limits on Gitanjali Gems shares was revised from 20% to 5% in a span of a week.

Market capitalisation loss

Over the course of fraud period beginning 14 February 2018, Gitanjali Gems had lost about
Rs 634.9 crore in the market capitalisation. The Mumbai-based jewellery maker Gitanjali Gems
commands a market capitalisation of Rs 114.46 crore as against a market capitalisation of
Rs 749.36 crore (according to the closing price on 12 February 2018) on BSE. 17

As a part of regulatory requirements, every listed firm has to declare company’s

financial results for a period of every quarter, six-month, nine-month and year-end. Gitanjali Gems
has not declared the quarterly results for the period of October-December of the financial year
2017-2018. Following which, National Stock Exchange fined Gitanjali Gems for not filing the
results. Taking a dig at Gitanjali Gems, Samir Arora of Helios Capital posted a tweet saying, “good
to see that NSE come down heavily on Gitanjali Gems for not filing the results for Q3. Such serious
violations from GG should not be allowed to go unpunished.” Only one small question – who does
Gitanjali Gems pay first – NSE or PNB?, Samir Arora added 18.

The diamond merchant Nirav Modi and his uncle Mehul Choksi have been the prime accused in
the PNB fraud amounting Rs 13,600 crore. Nirav Modi group companies and Gitanjali Gems have

16
https://www.financialexpress.com/market/gitanjali-gems-under-probe-in-pnb-fraud-loses-over-half-its-value-in-8-
days-with-no-end-in-sight/1077104/.
17
https://www.businesstoday.in/markets/company-stock/punjab-national-bank-fraud-gitanjali-gems-stock-tanks-40-
percent/story/270783.html.
18
https://www.financialexpress.com/market/gitanjali-gems-under-probe-in-pnb-fraud-loses-over-half-its-value-in-8-
days-with-no-end-in-sight/1077104/.
allegedly obtained buyer’s credit from several domestic lenders outside India on the basis of fake
LoU (Letters of Undertaking) issued by the rogue employees of PNB without registering the
transactions into the SWIFT system and following proper protocols.

Shares of the downtrodden and scam-hit Gitanjali Gems slipped below Rs 10 losing nearly 85% of
its value since India’s biggest banking fraud unravelled at nation’s second-largest PSU bank PNB.
The shares of Gitanjali Gems can now be termed as a penny stock as the scrips having share price
below Rs 10 are widely categorised as penny stocks. Shares of the Mehul Choksi-led Gitanjali
Gems have been on a continuous declining trend since the time Punjab National Bank has
informed about “unauthorised and fraudulent” transactions at the Brady House branch of Mumbai.
GITANJALI GEMS LIMITED STUDY OF UNDERCAPITALIZATION

19

The study of capitalization involves an analysis of three aspects20:

1. amount of capital,
2. composition or form of capital,
3. changes in capilatization.

It is found out by dividing the capitalised value of earnings by the number of outstanding shares.
Before the earnings are capitalised, they should be calculated on an average basis. It may be
pointed out at this place that longer the period cover by the study, the more representative the
average will be the period should normally cover all the phase of business cycle, i.e., good, bad,

19
Balance Sheet of Gitanjali Gems Limited, available at The Economics Times.
20
Supra 1.
and indifferent years. Some authors compare the par value of the share with the market value and
if par value is greater than the market value they regard it as a sign of over-capitalisation. Par value
> Market value.

The comparison of book and real values of shares is a better test in the sense that the book value
gives an idea about the company’s past career i.e., how it had fared during the last few years, and
its strength is determined by its reserves and surplus. Real value is a study of the working of
company in the light of the earning capacity in the particular line of business. It takes into account
not only the previous earnings or earning capacity of a concern but relates the earnings to the
general earning capacity of other units of the same nature. It is a scientific and logical test.

Book Value = Real Value (Fair capitalisation)

Book Value > Real Value (Over-capitalisation)

Book Value < Real Value (Under capitalisation)

Causes of over-capitalization: The following are the cases for over-capitalisation:

i) Promotion with inflated asset: The promotion of a company may entail the conversion of a
partnership firm or a private company into a public limited company and the transfer of assets may
be at inflated prices which do not bear any relation to the earning capacity of the concern. Under
these circumstances, the book value of the corporation will be more than its real value.

ii) The incurring of high establishment or promotion expenses (ex: good will, patent rights) is a
potent cause of over-capitalisation. If the earnings later on do not justify the amount of capital
employed, the company will be over-capitalised.

iii) Inflationary conditions: Boom is a significant factor for making the business enterprises over-
capitalised. The newly started concern during the boom period is likely to be capitalised at a high
figure because of the rise in general price level and payment of high prices for the property
assembled. These newly floated concerns as well as the reorganised and expanded ones find
themselves over-capitalised after the boom conditions subside.
iv) Shortage of capital: The shortage of capital is also a contributory factor of over-capitalisation,
the inadequacy of capital may be due to faulty drafting of the financial plan. Thus a major part of
the earnings will not be available for the shareholders which will bring down the real value of the
shares.

v) Defective depreciation policy: It is not uncommon to find that many concerns are over-
capitalised due to insufficient provision for depreciation/replacement or obsolescence of assets.
The efficiency of the company is adversely affected and it is reflected in its reduced profit yielding
capacity. vi) Liberal Dividend Policy: If corporations follow liberal dividend policy by neglecting
essential provisions, they discover themselves to be overcapitalized after a few years when book
value of their shares will be higher than the real value?

vii) Taxation Policy: Over-capitalisation of an enterprise may also be caused due to excessive
taxation by the Government and also their basis of calculation may leave the corporations with
meagre funds. Effects of over capitalisation: Over-capitalisation affects the company, the
shareholders and the society as a whole. The confidence of Investors in an over-capitalised
company is injured on account of its reduced earning capacity and the market price of the shares
which falls consequently. The credit-standing of a corporation is relatively poor. Consequently,
the credit-standing of a corporation is relatively poor. Consequently, the company may be forced
to incur unwieldy debts and bear the heavy loss of its goodwill In a subsequent reorganization.
The Shareholders bear the brunt of over capitalization doubly. Not only is their capital depreciated
but the income is also uncertain and mostly irregular. Their holdings have little value as collateral
security. An over-capitalised company tries to increase the prices and reduce the quality of
products, and as a result such a company may liquidate. In that case the creditors and the Labourers
will be affected. Thus it leads to the mis¬application and wastage of the resources of society.

Corrections for over-capitalisation: Overcapitalization can be rectified if the following steps are
taken:

1. Reorganisation of the company by selling shares at a high rate of discount.

2. Issuing less interested new debentures on premium in place of old debentures.

3. Redeeming preference shares carrying high dividend

4. Reducing the face value (par value) of shares.

The following are the causes for under-capitalization:

1. Underestimation of earnings: Sometimes while drafting the financial plan, the earnings are
anticipated at a lower figure and the capitalisation may be based on that estimate; if the earnings
prove to be higher the concern shall become under-capitalised.

2. Unforeseeable increase in earnings: Many corporations started during depression find

themselves to be under-capitalised in the period of recovery or boom due to unforeseeable increase
in earnings.

3. Conservative dividend policy: By following conservative dividend policy some corporations

create adequate reserves for depreciation, renewals and replacements and plough back the earnings
which increase the real value of the shares of those corporations.

4. High efficiency maintained: By adopting ‘latest techniques of production many companies

improve their efficiency. The profits being dependent on the efficiency of the concern will increase
and, accordingly, the real value of the corporation may exceed its ‘book value’. Effects of under-
capitalisation:

The following are the effects of under-capitalisation:

1. Causes wide fluctuations in the market value of shares.

2. Provoke the management to create secret reserves.

3. Employees demand high share in the increased prosperity of the company.

CONCLUSION & SUGGESTIONS

The conclusion is that neither undercapitalization, nor overcapitalization is desirable, as both are
evils. However, if one has to choose between the two, undercapitalization would be the right
choice:
(a) Overcapitalization leads to the conclusion that capital is ineffectively used and the earnings are
less than being fare.

(b) Undercapitalization, whereas, means that the rate of profit on capital invested is higher than
the normal return (enjoyed by similar companies in the same industry or when the value of assets
is more than the amount of capital).

(c) Undercapitalization has its own evil consequences but it is not as fatal as in the case of over
capitalization. Undercapitalization cannot continue indefinitely because more profitability means
more competition, more government intervention, and the environment pulls and pressures.

(d) Overcapitalization being a serious problem, later or sooner the company will have to be
reorganized and the consequences of the same will have to be borne by the shareholders and
creditors.

The company was going through problem of capitalization where the company was going in
overcapitalization but it was shown undercapitalization.