Meaning & Definition of Capital Structure Capital Structure is, ”the permanent financing of the firm represented by long-term debt, preferred stock and networth” -Weston & Brigham
Debt Any source that gives the funding agency the creditorship status In the horizontal form of Corporate Balance Sheet, it is the sum of III and IV items(Secured Loans and Unsecured Loans) on the Liabilities side of the Balance Sheet In the vertical format, it is the II item (which again contains Secured Loans and Unsecured Loans) on the side of Sources of Funds
Features of Debt Compulsory Payment of Interest Compulsory Repayment Only Fixed Interest No Annual Reports No Voting Rights
Merits of Debt Benefit of Leverage Cost of Raising Funds Tax Advantage Managerial Stability Easier SEBI Norms Flexible Features Stable Market for Securities Manageable Administrative Expenses Flexible Repayment Easier Regulatory Compliance
Demerits of Debt Compulsory Payment of Interest Solvency Affected Compulsory Redemption Charge on Assets Credit Rate Shopping
Equity Shareholders Fund or Ownership Capital Compulsory Component of the Capital Structure Sum of Equity Share Capital, Preference Share Capital and Reserves and Surplus Preference Shares are not a Popular Instrument
Equity Shares Common Stock/Ordinary Shares Full Fledged Ownership Total Entitlement to the Assets Repayment After the Satisfaction of Every Other Claim Preemptive Right Entitlement for Dividend, Bonus Shares and Other Such Rewards
Benefits of Equity Shares Basic for Capital Structure Better Solvency Gestation Period No Redemption No Charge on Assets No Shopping for Credit Rating Evaluation of Share Value Better Image Creation of Value Public Knowledge of Financial Information
Demerits of Equity Shares Tax Implication Management Control High Rates of Dividend Lack of Flexibility Stringent SEBI Norms Huge Issue Expenses High Volatility in the Stock Market Speculation Complex Shareholder- Management Relation Rigid Corporate Governance
Calculate Debt Equity Ratio of Abacus Limited whose Balance Sheet as on March 31, 2004 was as given below
Best Systems Limited had the following Balance Sheet as on 31-3-2004. Calculate Debt Equity Ratio.
2.3 Calculate Debt Equity Ratio of Arunodaya Chemicals 2000-01. Comment on the variation in the debt equity ratio from the year 2000 to the year 2001.
Solution for Arunodaya Chemicals2.3 For 2000: Long Term Debt = Deb + LT Loans = 9,00,000 + 6,00,000= 15,00,000 Equity = Eq.Shares + P&L A/c + Reserves = 3,00,000 + 1,19,800 + 80,200 = 5,00,000 Debt Equity Ratio = 15,00,000 : 5,00,000 = 3:1
De Ratio for 2001 LT Debt = 6,00,000 + 8,00,000 = 14,00,000 Equity = 4,00,000 + 1,82,500 + 1,17,500 = 7,00,000 DE Ratio = 14,00,000 : 7,00,000 = 2:1 De Ratio has come down due to lesser component of Debentures even though Lt Loan has gone up. Every component of equity has also gone up.
Debt Equity Mix Significance of a High Debt Equity Mix: Reduced Tax Liability, Higher EPS Significance of a Low Debt Equity Mix: Better Risk Management Zero Debt Capital Structure and Its Relevance -Reducing Corporate Tax Rates -Equity Tied Image -Opportunity for Mergers & Acquisitions -Other Benefits Trading on Equity
Preparation of Statement of Income Leverages: Operating Leverage, Financial Leverage and Combined Leverage Degree of Leverages Significance of Each Leverage: -Sales-EBIT-EPS Relation -Measurement of Risk Levels -Behaviour of Costs