MBA Accounting & Finance

WHEN DO YOU CONSIDER AN ENTITY BECOMES OVERCAPITALIZE?

• Generally, an entity is said to be overcapitalized when it has fixed assets in excess of its actual needs

and

• A reasonable return is not being earned on the investments of these fixed assets

• Sometimes, we might consider an entity overcapitalize when it has substantial amounts of intangibles represented by inflated values like in the case of patents, trademark, good will and other deferred assets. Hence instead of looking at the shareholder funds alone, there is a need for the deduction of these intangibles assets from the shareholder fund to get the real tangible worth of the entity.

SOME OF THE TELL-TALES OR SYMPTOMS OF OVERCAPITALIZATION

• High proprietary ratio ( refer to my previous article on this)

• Low earnings per share

• Low assets utilization particularly with a lot of fixed assets and small revenue generated

• Too much capital invested in unproductive fixed assets

SALIENT POINT TO NOTE

With overcapitalization, management needs to cut the cloth to a smaller piece to generate higher earnings. This is by reducing the share capital ( court proceeding), disposal of idling fixed assets and business reengineer to increase its revenue streams.