Effects Of Undercapitalisation

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Effects of undercapitalisation

1.    On company:

Financial stability and solvency of the company is not affected due to undercapitalisation, but still affects the company adversely.

(a)    As earnings per share ratio is very high, it increases the competition unduly by creating a feeling that the line of business is very lucrative.

(b)    Increasing amounts of profits increases the tax liability of the company.

(c)    Marketability of the company gets restricted due to very high market prices of shares.

(d)    Very high profitability of the company induces the employees to demand increase in wages, reduced working hours, more welfare scheme and more social amenities.

(e)    Very high profitability of the company creates a feeling among the customers that the company is charging very high prices for its products. They try to bring pressure on the company for reducing the prices of the product.

(f)    Increasing profitability coupled with unrest among the employees as well as consumers increases the possibility of government control and intervention over such companies. This proves to be quite embarassing for the company.

2.    On shareholders:

Generally, the shareholders of an undercapatalised concerns are benefited. Firstly they get a very high dividend income regularly. Due to the the increasing share prices, the investment of shareholders in the company appreciates considerably which can be encashed at any time. Secondly, in times of need, the shareholders may get loans on the security of these shares on easy terms due to high credit standing of the company in market. However, the shareholders of the undercapitalised concerns may suffer in the sense that the market for the shares is limited due to very high market prices of the shares.

3.    On society:

The effects of undercapitalisation on the society as a whole may not necessarily be adverse ones. It may encourage new entrepreneurs to start new ventures or existing ones to expand. This may increase the industrial production and reduce the unemployment problems. The consumers may get the variety of products at the competitive prices.

However, society may not be benefited if the state of undercapitalisation is not taken right spirit. If the feeling is developed among the workers and consumers that they are being exploited due to ever-increasing profitability of the undercapitalised company, it may disturb not only the company itself but also the society as a whole. Possibility of government intervention and introduction of various control measures (say in the form of prices control, dividend ceiling and dividend freeze) increases.