In this article, I’m going to tell you about the definition of Capital Structure, Capital Structure Planning and the factors affecting capital structure of a company.

What is Capital Structure?

Capital structures mean to be the amount of debt and/or equity used by a firm, which finances its operations and finances its assets. The structure usually expresses as a debt-to-equity or debt-to-capital ratio.

Loans and equity capital used for the operation, capital expenditure, acquisition and other investments of a business. Tradeoffs are firm when they have to decide whether they are to increase the debt or equity and the managers have balanced two attempts and have identified the optimum capital structure.

capital structure planning

Capital structure planning is very important, to keep the business alive for a long time. After viewing the company’s balance sheet, you see two aspects of the balance sheet. One side is the liability side and the other side is the asset side. The liability side is a combination of company finance which the company has collected from internal and external sources and it has been used or done for the development of the company.

The liability of the balance sheet is made under the side right capital structure scheme. Finance Managers and other promoters decide which source of fund or fund should be chosen after monitoring the factors affecting capital structures. Therefore, capital structure planning creates strong balance sheets. Proper capital structure planning also increases the power of the company to face losses and changes in financial markets.

Factors Affecting Capital Structure

Factors affecting capital structure

The capital structure of any concern depends on a large number, such as business on profit or equity, growth of company, size of nature and business, idea of ​​maintaining control, flexibility of capital structure, new cost of fulfillment of investors’ needs.

Time to do, corporate tax rate and legal requirements It is not possible to rank them because all such factors are of different importance and the impact of the individual factors of a firm varies over time. Funds need every time. The financial manager has profitable capital structure. Factors affecting capital structure –

1. Financial leverage of trading on equities:

The use of long-term fixed interest loans and preference share capital with equity share capital called trading on equity or financial leverage. The use of long-term debt increases, the income per share increases if the firm gives more returns than the cost of the loan.

Earnings per share also increase with the use of capital per share, but due to the fact that the interest deduction allowed when calculating tax, the effect of availing the loan is very high. However, levitation can also work adversely if the rate of interest on long term loans is higher than the expected rate of firm earnings. Therefore, caution requires to plan a firm’s capital structure.

2. Sales growth and stability:

The capital structure of a firm is strongly influenced by the increase and stability of its sales. If a firm’s sales are expected to remain quite stable, then it can increase the high level of credit. The stability of the sale ensures that the firm will not face any difficulty in fulfilling its set commitments of interest repayment of the loan.

Similarly, the rate of increase in sales also influences the capital structure decision. Generally, sales growth is high, loan financing can be more used in the firm’s financing. On the other hand, if the sale of a firm is getting excessive fluctuations or declines. Then it should not be financing loan in its capital structure, as far as possible.

3. Cost of capital:

The cost of each rupee invested in a firm is the cost. The cost of capital is the minimum return required by its suppliers. The capital structure should be provided for the minimum cost of capital. The main sources of finance are equity for a firm, preference debt capital, and share capital. The expected return by capital suppliers depends on the risk they have to make. In the Factors affecting capital structure, this is an important factor.

4. Control:

Determination of capital structure also operates in the company’s willingness to maintain control. The issue of equity shares involves the risk of losing control. In this way, if the company is interested – in order to maintain control. He should prefer to use debt and preference share capital for equity share capital. However, excessive use of debt and preference capital can lead to loss of control and other bad consequences. You can read about Capital Structure Planning in above Paragraph.

5. Flexibility:

In brief, The word flexibility refers to the ability of the firm to adjust its capital structure for the requirements of changing circumstances. A firm with flexible capital structures will have no difficulty in changing their capitalization or source of funds. The degree of flexibility in the structure of capitals is mainly.

  • (i) dependent on the unutilized loan capacity of the firm,
  • (ii) redemption in the fixed fee
  • (iii) the conditions of flexibility and
  • (iv) restrictive stipend in loan agreements.

6. Profitability:

A capital structure should be most profitable from the point of view of equity shareholders. Therefore, within given barriers, maximum loan financing should choose to increase returns available to equity shareholders.

7. Cash Flow Availability:

EBIT – EPS analysis, earning growth and coverage ratio are very useful indicators. Of the efficiency of a firm to meet its set obligations at different levels of EBIT. Therefore, an important feature of sound capital structure is ability to generate cash flow to determine service tax of firm. This is the seventh Factors affecting capital structure.

however, When planning capital structure, the proportion of the fixed charges of the net cash flow should check. This ratio reflects the total number of times when the charges fixed by net cash inward. This coverage is more than one firm’s ability to take another source of funds to fixed rate of interest and dividends.

8. Company Features:

Moreover, Specific characteristics of a company play an important role in determining its capital structure. In relation to its size, nature, credit stand, etc. A small size company will not be able to mobilize long term loans at reasonable rates on convenient terms. Therefore, such companies rely on equity share capital. And reserves to a significant extent and surplus for their long-term financial requirements. Factors affecting capital structure.

9. Regulatory framework:

Capital structure also influenced by government rules. For example, banking companies can raise money by issuing share capital alone, no other security. Similarly, it is compulsory to maintain the debt-equity ratio given to other companies while raising funds.

Various ideal debt-equity ratios like 2: 1; 4: 1; 6: 1 has been set for different industries. The public issue of shares and debentures is to made under SEBI guidelines.

10. Stock market position:

The stock market’s position refers to the tendency toward the top or the bottom in the capital market. In additional, Both of these positions influence by the selection of sources of finance. When the market is sluggish, investors are afraid to invest in share capital due to high risk.

11. Floatation Costs:

MOREOVER, The cost of Floatations called expenses which are spending while issuing securities. These include the commission of underwriters, brokerage, stationery expenses, etc. Generally, issuing debt capital’s cost is less than share capital. It attracts the company towards debt capital.

Capital rationing – Definition | Overview and Types