What is Capitalising?
Capitalising is a method of accounting where the value of an asset is expensed over the useful life of that asset, and not just during the period of incurring the cost. An item is considered to be capitalised when it is seen as an asset rather than as an expense. That is the expenditure on this item is to be recorded in the balance sheet rather than in the income statement.
When it comes to the finance sector, capitalisation means the cost of capital that takes the form of a corporation’s stock, retained earnings, and long-term debts. On the other hand, the number of outstanding shares multiplied by the share price refers to market capitalisation.
Capitalisation in Finance
Here, capitalisation refers mostly to a company’s capital structure. It points at the book value cost of capital, i.e. the sum of a company’s stocks, retained earning, and long-term debt.
Similar to book value is the market value; it depends on the price of the company’s stock. You can calculate the market value cost of capital by multiplying the company’s shares with the number of outstanding shares in the market. Consider that a company has a total of 10,000 outstanding shares, and the stock has a price of Rs.20. The market capitalisation of the company is Rs.2,00,000.
Companies are categorised as large-cap, mid-cap, and small-cap based on their market capitalisation value. A company with a market capitalisation of more than $10 billion is called a large-cap company, the one with a market capitalisation between $2 billion and $10 billion is a mid-caps company, and between $300 million and $2 billion is a small-caps company.
What is Overcapitalising and Undercapitalising?
Overcapitalisaing is a state when the company earnings are not sufficient to cover the cost of capital. One such situation can be when the company has no capital to pay dividends to shareholders.
Undercapitalisation is a state when the company does not need funds from outside because it has earned high profits, which was underestimated before.
