What is Capital Rationing

Capital Rationing in simple words refers to a situation where an organization cannot undertake all the projects which are having positive net present value because of shortage of capital. When company do capital rationing than it will select only that project which gives the company maximum profit.

Capital rationing can be better understood with the help of an example suppose you are having $100 and you go to a restaurant where pizza and burger both cost $100 and you are hungry and can eat both if you are given an option but since you have only $100 you will have to choose either pizza or burger. In the same way if a company has limited capital than it cannot take all the projects but only select those projects which it can afford with the limited amount of capital.

Companies go for capital rationing when they are not able to raise fresh capital from the markets because of external factors like slowdown in an economy, higher interest rate environment etc…, or due to internal factors like excessive debt in the balance sheet of the company, no further issue of equity capital so as to prevent dilution of control of existing shareholders of the company etc……