This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
We have now considered the financial forms of organization of business enterprises and the various types of security issues which are exchanged for cash and other property acquired by the business. The total par value of all the security issues outstanding at any given time is usually referred to as the "capitalization" of an enterprise. In some jurisdictions there is a legal meaning attached to the word "capitalization" which is wholly distinct from its popular meaning; it being, in the legal sense, the total par value of the authorized capital stock of a corporation. Wherever the word is used in this volume, however, it may be understood in its popular sense.
"Capitalization" is distinguished from "capital" or "capital funds," by which we mean the actual value of the investment in the business. The vague expression "overcapitalization" is intended to indicate a state of affairs where the nominal value of the outstanding stocks and bonds is in excess of the real value of the investment. It has already been pointed out in discussing methods of paying for capital stock, that there need not necessarily be a close correspondence between "capitalization" and "capital" or "capital funds" actually invested.
Another phrase frequently used which should be distinguished, is "capital assets," under which term are included those assets of a business which are of a permanent nature and which are essential to its continuance. "Capital assets" are distinguished from "current assets." If a manufacturing concern, for instance, has a plant worth $1,000,000, inventories of $300,000, and cash and accounts receivable of $200,-000, we should say that its capital assets were $1,000,000 and its current assets $500,000.
The capitalization of an enterprise is in a sense a valuation on the part of the organizers of the net worth of the enterprise. At the beginning it is supposed to be, at least as a matter of legal theory, a fairly accurate valuation. As time goes on, it is recognized that there will necessarily be changes in the status and value of the various assets and liabilities; and the financial results of these changes are supposed to be shown in the surplus or profit and loss accounts. The "capitalization" plus the surplus theoretically measures the exact value of the permanent investment in the business. However, the necessary inaccuracies and arbitrary estimates of accounting practice make it very difficult even to approach this theoretical relation in every-day practice.