Ms04

Q1A. What do you understand by capitalization of earning? How is the value of a firm ascertained with the help of its earnings? Explain with an example.

A. The term 'capitalization' is used in quantitative aspect and refers to the amount at which a company's business can he valued. The term, actually, has been used by different authors in a variety of senses in the literature of financial management. Some authors have used the term in broader sense while others in narrow sense. In a broader sense, the term capitalization has been used in the sense of financial planning. It means, it includes the amount of capital to be raised, the securities through which it is to be raised and the relative proportion of different classes of securities to be issued and the administration of capital. The analysis of this interpretation shows that it is nothing less than financial planning.

In the narrow sense of the term 'capitalization' means the amount at which a company's business can be valued. The traditional authors define the term in this sense. This interpretation of the term is more specific though restricted, it is in this sense that the term is used here. Dewing takes it to mean the sum total of the par value of all shares. In business it refers to either of the following views:

* The total par value of all the securities i.e., shares and debentures- outstanding at a given time and surplus in whatever form it may appear; or

* The total par value of all securities at a given time and valuation of all other long-term obligation plus surplus in whatever form it may appear.

A few definitions of capitalization are being reproduced below in order to understand the term well:

* According to Gerstenbergh, "For al practical  purposes, capitalization means the total accounting value of all the capital regularly employed in the business."

* According to A.S. Dewing, "The term capitalization, or the valuation of the capital includes the capital stock and...