This document discusses factors that affect a company's capital structure. It defines capital structure as how a firm finances its operations through various sources of funds such as debt, equity, short-term debt, and other financing options. It then lists 14 factors that influence a company's capital structure decisions, including control interests of shareholders, risks, tax considerations, cost of capital, flexibility, investors' attitudes, legal provisions, growth rate, market conditions, profitability, floatation costs, cost of debt, cost of equity capital, and government policies. Maintaining an optimal capital structure is important for balancing business risks and maximizing shareholder value.
2. CAPITAL STRUCTURE
DEFINITION
The capital structure is how a firm finances its overall operations and
growth by using different sources of funds. Debt comes in the form of
bond issues or long-term notes payable, while equity is classified
as common stock, preferred stock or retained earnings. Short-term
debt such as working capital requirements is also considered to be part of
the capital structure.
3. COMPONENTS
A firm's capital structure can be a mixture of long-term debt, short-term
debt, common equity and preferred equity. A company's proportion of
short- and long-term debt is considered when analyzing capital structure.
When analysts refer to capital structure, they are most likely referring to a
firm's debt-to-equity (D/E) ratio, which provides insight into how risky a
company is.
Usually, a company that is heavily financed by debt has a more aggressive
capital structure and therefore poses greater risk to investors. This risk,
however, may be the primary source of the firm's growth.
4. FACTORS INFLUENCING
1.CONTROL INTERESTS
According to this factor, at the time of preparing capital structure, it should be
ensured that the control of the existing shareholders (owners) over the affairs
of the company is not adversely affected. If funds are raised by issuing equity
shares, then the number of company’s shareholders will increase and it directly
affects the control of existing shareholders. In other words, now the number of
owners (shareholders) controlling the company increases.
2.RISKS
The economy where a firm conducts business is also subject to unforeseen
risks. In the contemporary business world, size no longer assures economic
survival. Therefore, finance executives attempt to consider every possibility
imaginable to mitigate negative economic events.
5. 3.TAX CONSIDERATION
Debt payments are tax deductible. As such, if a company's tax rate is high, using
debt as a means of financing a project is attractive because the tax deductibility of
the debt payments protects some income from taxes.
4.COST OF CAPITAL
Cost of capital determines the type of securities to be issued. During depressions it
is better to raise capital structure through preference shares and debentures and
during boom equity shares are better.
5.FLEXIBILITY
The firm while deciding the capital structure shall ensure flexibility in its capital
structure. The capital structure should be such that it always provides scope for
raising funds through debts.
6. 6.INVESTORS ATTITUDE
Attitudes of investors is another factor which determines the equities to be
issued. The investors may be venturesome or cautious or less cautious. Equity
shares can best to be invested to investors who are venturesome because
they are prepared to take risks.
7.LEGAL PROVISIONS
While determining capital structure the company should take care of the
relevant provisions of various law framed by the government from time to
time. It should also take case of norms set by financial institutions ,SEBI , stock
exchange etc.
7. 8.GROWTH RATE
Firms that are in the growth stage of their cycle typically finance that growth
through debt, borrowing money to grow faster. The conflict that arises with this
method is that the revenues of growth firms are typically unstable and unproven.
As such, a high debt load is usually not appropriate.
9.MARKET CONDITIONS
Market conditions can have a significant impact on a company's capital-structure
condition. Suppose a firm needs to borrow funds for a new plant. If the market is
struggling, meaning investors are limiting companies' access to capital because of
market concerns, the interest rate to borrow may be higher than a company would
want to pay. In that situation, it may be prudent for a company to wait until market
conditions return to a more normal state before the company tries to access funds
for the plant.
8. 10.PROFITABILITY
While deciding or planning capital structure ,the firm should keep the
objective of maximizing the shareholders wealth. The firm shall work out
proper EBIT EPS analysis. Then only it can select that combination which
gives highest value of EPS for a given level of EBIT.
11. FLOATATION COSTS
Floatation costs are those expenses which are incurred while issuing
securities (e.g., equity shares, preference shares, debentures, etc.). These
include commission of underwriters, brokerage, stationery expenses, etc.
Generally, the cost of issuing debt capital is less than the share capital. This
attracts the company towards debt capital.
9. 12.COST OF DEBT
The capacity of a company to take debt depends on the cost of debt. In case
the rate of interest on the debt capital is less, more debt capital can be utilized
and vice versa.
13. COST OF EQUITY CAPITAL
Cost of equity capital (it means the expectations of the equity shareholders
from the company) is affected by the use of debt capital. If the debt capital is
utilized more, it will increase the cost of the equity capital. The simple reason
for this is that the greater use of debt capital increases the risk of the equity
shareholders.
14.GOVERNMENT POLICIES
Capital structure is also influenced by government regulations. For instance,
banking companies can raise funds by issuing share capital alone, not any
other kind of security. Similarly, it is compulsory for other companies to
maintain a given debt-equity ratio while raising funds.