The indicator of overcapitalization / undercapitalization

The indicator of overcapitalization / undercapitalization is one of the indicators of indebtedness and financial structure and possibly also liquidity.

The ratio indicates the proportion in which are fixed assets financed by long-term funds. The analysis provides similar result as the analysis of working capital.

Calculation formula

Interpretation

• if > = 1 overcapitalization, i.e. the company covers by long-term funds also current assets

→ lower risk (serves as a buffer, because it is possible to use the money raised from the potential sale of current assets financed by long-term sources for something else without compromising the stability of the entity)

→ lower efficiency, because long-term funds tend to be more expensive than short-term funds

• if <1 = undercapitalization, i.e. the company covers a part of its fixed assets by short-term funds

→ risk that the entity will be forced to sell this part of fixed assets to be able to pay its short-term liabilities

The indicator should surely be greater than 1. However, there is no generally recommended value; it depends on specific conditions.