Capital rationing is the process of regulating the capital expenditure when capital is scarce. When capital is in limited supply i.e. raising capital is not easy then company will have to pick and choose between what investment choose and what to just let go even if all the investments are favourable. This is done by imposing conditions and limitations on the way capital is applied on different investment opportunities.
When company faces problems in raising finance due to external factors or in other words conditions are imposed on company from outside then it is called hard capital rationing. For example lenders through contract limit the company’s ability raise debt finance beyond a particular gearing level.
When conditions or limitations are imposed by the management of the company i.e. conditions or limitations are imposed on company from inside then it is called soft capital rationing. For example directors in BOD meeting decided that investments will not be made in such projects that result in overall ROI to be less than 10%.