The term Capitalization is used only in relation to companies and not in respect of firms or sole-proprietorships.
It is distinct from share capital which refer only to the paid-up value of shares issued and definitely excludes bonds and other forms of borrowings. Similarly, it should be distinguished form ‘capital’. The term capital refers to the total investment of a company in money, tangible assets like goodwill. It is in a way the total wealth of a company. When used in the sense of net capital, it indicates the excess of total assets over liabilities. Here, then, it includes “the gains or profits from the use and investment of the capital that has not been distributed to the stockholders” and excludes losses that have resulted from the use of capital. Capitalization, on the other hand, refers only to the par value (i.e., face value indicated on the security itself) of the long-term securities (shares and debentures) plus by any reserves which are meant to be used for meting long-term and permanent needs of a company. Thus ‘capital’ includes all the loans and reserves of the concern but ‘Capitalization’ includes only longterm loans and retained profits besides the capital.
In its narrow sense, the term capitalisation is used only in its quantitative aspect and refers to the amount at which a company’s business can be valued.
Most of the traditional authors define the term in this sense. Since this interpretation of the term is more specific though restricted, it is in this sense that the term is used here. The decision about the form of capitalisation, i.e., the type of securities to be issued and the relative proportion of each type is discussed under ‘Capital Gearing’. Here, we will concentrate mainly on the amount of capitalisation.
Various authors have attempted definition of the term capitalisation. The essence of all that they have stated on the subject is that capitalisation is the sum-total of all long-term securities issued by a company and the surpluses not meant for distribution. Capitalization may be said to be composed of (1) the value of shares of different kinds, (2) the value of surpluses, whether capital surpluses or earned surpluses, and (3) the value of bonds and debentures issued by a company still not redeemed. It may be added for clarification that earned surpluses represent the surplus profits accumulated over a period of time and capital surpluses are those arising from other sources. If, for example, the company sets apart a part of its profits with a view to using such reserves for meeting its long-term financial requirements, such surpluses will be called earned surpluses. On the other hand, if an asset of the company is sold at a profit, the surplus resulting from the deal will be a capital surplus. From the financial angle, such surplus is also meant for long-term use in the concern.
There is a growing number of authors who regard capitalisation as synonymous with financial planning.
The financial plan of company incorporates decisions about the amount of capital to be raised, the securities by the issued of which it is to be raised, and the relative proportions of the various classes of securities to be issued, as also the administration of the capital. Used in a broad sense, therefore, capitalisation refers to the process of determining the plan or patterns of financing. It includes not merely the determination of the quantity (amount) of finance required for a company but also the decision about the quality of financing (which type of security is to be issued and to what extent).