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Definition

This is the process when loans or interest payable are converted to capital. This alters the gearing or borrowing ratio of the company by shifting loans into permanent capital. It also improves the operating performance of a company, whereas a loan usually carries obligatory interest charges (although many inter-company loans are interest-free) which must be deducted from operating income to arrive at net income. Shareholders are only paid dividends if there is sufficient net income. Banks will often capitalise loans outstanding from a borrower who is in trouble, by converting the loan into capital but only if they perceive that the chances of recovering the money would be improved by doing so. By allowing the company to continue operating without the burden of monthly interest repayments and provided that company liquidation is unlikely to result, the bank hopes to fully recover the outstanding amount through dividend payments or by selling their equity once the company is functioning well.

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