Capitalization Question: Download Questions PDF
Do you know the theories to determine the amount of capitalization?
Answer:
The two main theories which are involved with the amount of capitalization are as follows:-
1) Cost Theory - In this theory the value of the company is decided by adding certain factors such as:-
(i) Cost of fixed assets i.e. Machinery, mechanical items
(ii) Working capital i.e. the capital which is required for continuous operation of the company
(iii) Cost of establishment of business promotion i.e. Expenses in doing the advertisements
These factors allow the promotion team to know the amount of capital which has to be raised to fulfill the promotion job. The true income of the company is been found out by its earning not by its investment in other states. For example if some assets becomes out of date and some idle then the earnings will fall but that fall of capital won't affect the investment made by the company in other company's business.
2) Earnings Theory: In this theory true value of an enterprise depends on its earnings capacity. The value of the company capitalization will be same as the estimated earning of the company. To find out this a company has to prepare a profit and loss account and then check regularly to see the effect of their sales over the years to find out how correct there estimations are. The earnings will be compared to the actual earning and the adjustment will be made according to that. The promotion team will then see the up and down of the earnings and then overall decision will be taken on management and how to simulate the earning to increase the revenue of the company.
For example if there is a company which has an estimated average profit of Rs. 25,000 in first few years and earning a return of 5% on their capital. The capitalization will be: (25,000*100)/5 = Rs. 5, 00,000
1) Cost Theory - In this theory the value of the company is decided by adding certain factors such as:-
(i) Cost of fixed assets i.e. Machinery, mechanical items
(ii) Working capital i.e. the capital which is required for continuous operation of the company
(iii) Cost of establishment of business promotion i.e. Expenses in doing the advertisements
These factors allow the promotion team to know the amount of capital which has to be raised to fulfill the promotion job. The true income of the company is been found out by its earning not by its investment in other states. For example if some assets becomes out of date and some idle then the earnings will fall but that fall of capital won't affect the investment made by the company in other company's business.
2) Earnings Theory: In this theory true value of an enterprise depends on its earnings capacity. The value of the company capitalization will be same as the estimated earning of the company. To find out this a company has to prepare a profit and loss account and then check regularly to see the effect of their sales over the years to find out how correct there estimations are. The earnings will be compared to the actual earning and the adjustment will be made according to that. The promotion team will then see the up and down of the earnings and then overall decision will be taken on management and how to simulate the earning to increase the revenue of the company.
For example if there is a company which has an estimated average profit of Rs. 25,000 in first few years and earning a return of 5% on their capital. The capitalization will be: (25,000*100)/5 = Rs. 5, 00,000
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