Capitalization is of two kinds—quantitative and qualitative: Quantitative. The capitalization is the total par value of the outstanding stock, bonds and long term notes of the company. Trade credit, bank loans, and other current indebtedness are not included.
Qualitative. Capitalization is the plan of distri bution of the control, risk and income of the busi ness among the various security holders. This defini tion relates to the kind of securities, and not to the amount; whereas the first definition relates to the amount of securities, and not to the kind. To avoid confusion, we shall refer to this qualitative definition as the plan of capitalization.
5. Authorized and outstanding capital.—Legal theory does not always harmonize with financial fact. Out of this discrepancy grow many terms in common usage that are not justified by accurate definition.
The term "authorized capital" is one of these. By this term is really meant "authorized capitalization." The state, in chartering a company, limits the number of shares and the par value of the shares which the company may issue, and this limit is known as "au thorized capital." The state fixes no limit on the value of the company's assets, bat merely on the par value of the stock, and it is therefore capitalization and not capital that is authorized.
The outstanding capitalization of the company con sists of the total par value of securities that have been subscribed and paid for, regardless of their real value, or the amount authorized to be issued. The author ized capitalization does not include bonds. Every company has the inherent right to borrow for the pur pose of conducting its business without authority in the charter, and bonds are issued under this general borrowing power.
Thus, we say that the United States Steel Com pany has an authorized capitalization of $550,000,000 common and $550,000,000 preferred stock. But its actual outstanding capitalization includes also $304, 000,000 in bonds.
6. Kinds of corporate corporate cap ital, somewhat in the order of its bonding value, may be classified as follows: 1. Land 2. Buildings 3. Equipment 4. Securities owned and necessary to the business 5. Securities and other unattached or outlying properties not necessary to the business 6. Raw material and supplies 7. Work in process 8. Finished product
9. Bills and accounts receivable 10. Cash 11. Good will, including secret processes, patents, copyrights and trade names.
While all forms of corporate assets are supposed to be productive, as otherwise the corporation would not have acquired them, they nevertheless represent dif ferent degrees of productiveness and risk. Many forms of assets cannot be converted readily into cash, except at great sacrifice. Second hand machinery, for instance, is often difficult to sell, altho, it may be of great value to a running business. Capital tied up in unproductive assets or in forms not easily con vertible into cash is naturally not good security for loans. Such assets, therefore, must be provided by the sale of capital stock, which absorbs the risk of cor porate ventures, while bondholders provide funds to purchase the more staple and productive assets. This fact lies at the basis of every scheme of capital ization and renders necessary the close analysis of each enterprise before attempting to finance it.
7. Compensating the• owner of capital.—We have already defined capitalization as the method of dis tributing control, risk and income among security holders. Those who contribute capital to a corpora tion must be paid for its use. Corporations are formed to conduct business for profit, and these profits appear in the form of dividends upon stock or interest upon bonds and notes. But the element of risk is ever present in corporate enterprise, and for assuming it the security owner demands more than mere interest for the use of his capital. This addi tional charge may be designated as "premium for the assumption of risk." On the other hand, there are special advantages to be had from participating in the management or con trol of certain corporations, aside from the divi dends or interest received. Directors of banks and insurance companies, or of large industrial and rail way corporations, for instance, feel that the prestige of their position is worth something apart from the direct earnings upon their investments. How, then, shall the owners of this capital be compensated for its use The answer involves the entire plan of capitaliza tion. There are four elements to consider: 1. Control 2. Management 3. Risk 4. Income.