Meaning of under Capitalisation? The symptoms of under Capitalisation? The causes of under Capitalisation?

Under Capitalisation is just reverse of over capitalisation. A company is under capitalised of the real value is higher than the book value of its assets. In other words under Capitalisation occurs when a company's actual capitalisation is lower than its proper capitalisation. Thus, the phase under Capitalisation should never be misconstructed with inadequate of capital. Under Capitalisation is an index of effective and proper utilisation of funds employed in the enterprise.

               According to S.W. Gerstenberg, " A company may be under capitalised when the rate of profits it is making on the total capital is exceptionally high in relation to the return enjoyed by similarly situated companies in the same industry."

                According to Bonneville and Dewey," When a corporation earns exceedingly high income on its capital, it is said to be under capitalised."

     Thus, under Capitalisation is associated with an effective utilisation of investments are exceptionally high rate of dividend and the enhance prices of shares.

         To sum up :- 

Real value>Book value= Under Capitalisation

Here value means the value of assets and shares are the concerns in the market.

Symptoms of under Capitalisation

(i) Low proprietory Ratio: This Ratio establishes relationship between shareholders fund divided by total assets. 

         PR= shareholders fund

                     Total assets

 A low proprietory Ratio is generally taken as a symptom of under Capitalisation.

(ii) High rate of earnings: If the rate of earnings of the company is exceedingly higher than the similarly situated companies in the same industry, it should be taken as an indicator of under Capitalisation.

(iii) Low current ratio: This Ratio is computed by dividing the current asset by current liabilities. This should not be less than 1:1. If the current asset are less than current liabilities it indicates under Capitalisation.

(iv) Higher rate of dividend: Higher rate of dividend than the rate declared by other similar companies indicate under Capitalisation.

(v) Market value of shares: If the real value or market value of shares is higher than their book value, it may taken as symptom of under Capitalisation.

(vi) Value of assets: If the real value of the company's asset is higher than the book value, it may be another indicator of under Capitalisation.

Causes of under Capitalisation:-

Under Capitalisation may be caused by the following:

(i) Under estimation of capital requirements: Under estimation of capital requirements by promoters in the beginning leads to the situation of under Capitalisation.

(ii) Under estimation of earnings: If earnings of a new venture were under estimated and the enterprise was capitalised accordingly, it may find itself in a condition of under Capitalisation afterwards.

(iii) Conservation assets management policy: A conservative and over cautions management may write down the value of assets below their fair value. It ultimately leads to under Capitalisation in the long run.

(iv) Promotion during deflationary period: 

Companies which have been set up in deflationary conditions generally become under capitalised after the deflation is over.

(v) Unforeseenable increase in earnings : If there is unforeseen increase in earning, due to exceptions by government in corporate taxations, it also leads to under Capitalisation.

(vi) High level of efficiency: By employing new techniques to production or rationalisation schemes, the operating efficiency of the company can be improved. This may be another cause of under Capitalisation.

(vii) Conservative dividend policy: Companies following conservative dividend policy build a substantially large funds for replacement and renovation of assets or for financing expenses programmes. It increases the rate of earning as well as rate of dividend.

(viii) Ploughing back of profits: When a company reinvest it's profits and reserves in the business, it's earning are increased leading to enhance rate of dividend to equity shares holders.