CAT / FIA FFM Syllabus A. Working Capital Management - Over-capitalisation and Over-trading - Notes ^{7 / 8}

Over-capitalisation

This is when the total owned and borrowed capital exceeds the fixed and current assets.

It is when profits of the company are not sufficient to pay interest on debentures and borrowings and dividend to shareholders.

There are 3 indicators of over-capitalisation:

1. Over-valued

   The value of Fixed assets is higher than the actual cost on the market.

2. Lower Earnings

3. Idle Funds
    
   Company may have funds which might not have been used properly 

   e.g. Money invested in such projects that are giving very low profits.

Effects of Over-capitalisation on Company:

1. The shares of the company may not be easily marketable because of reduced earnings per share.

2. The company may not be able to raise fresh capital from the market.

3. Reduced earnings may force the management to follow unfair practices. It may manipulate the accounts to show higher profits.

4. Management may cut down expenditure on maintenance and replacement of assets. Proper amount of depreciation of assets may not be provided for.

5. Because of low earnings, reputation of the company would be lowered.

Over-trading

Overtrading takes place when a business accepts work and tries to complete it, but finds that fulfilment requires greater resources such as:

• more people

• working capital than are available.