Capitalization

Loading the player...

What is 'Capitalization'

Capitalization, in accounting, is when the costs to acquire an asset are expensed over the life of that asset rather than in the period it was incurred. In finance, capitalization is the sum of a corporation's stock, long-term debt and retained earnings. Capitalization also refers to the number of outstanding shares multiplied by share price.

BREAKING DOWN 'Capitalization'

Capitalization has two meanings in accounting and finance. In accounting, capitalization is an accounting rule used primarily by asset-intensive companies such as manufacturing or construction. In finance, capitalization is a quantitative assessment of a firm's capital structure.

Capitalized Assets

In accounting, the goal is to record revenue and expenses in the period when they are incurred. For example, office supplies are generally expensed in the period when they are incurred. However, some office equipment may provide a benefit to the business for more than one accounting period. These are items such as computers, cars and office buildings. The costs of these items are recorded as assets to be used or expensed in future periods. The costs are said to be capitalized, not expensed. Accountants like capitalized assets because they are not expensed against earnings in the current period. A company can make a large purchase but expense it over a 20- to 30-year period. As these assets are used to generate revenue, a portion of the cost is written off. This process is known as depreciation or amortization.

Market Capitalization

Another aspect of capitalization refers to the company's capital structure. Capitalization can refer to the book value of capital, which is the sum of a company's long-term debt, stock and retained earnings. The opposite of book value is market value. The market value of capital depends on the price of the company's stock. It is calculated by multiplying the price of the company’s shares by the number of shares outstanding in the market. If the total number of shares outstanding is 1 billion and the stock is currently priced at $10, the market capitalization is $10 billion. Companies with a high market capitalization are referred to as large caps. Companies with medium market capitalization are referred to as mid caps, and companies with small capitalization are referred to as small caps.

It is possible to be overcapitalized or undercapitalized. Overcapitalization occurs when earnings are not enough to cover the cost of capital such as interest, or payments to shareholders, such as dividends. Undercapitalization occurs when there's no need for outside capital because profits are high and earnings were underestimated.