1) The capital structure of a firm refers to how it finances its operations and growth through different sources of funds, including debt, equity, and retained earnings. 2) Several factors influence a firm's capital structure decisions, including business risk, tax exposure, financial flexibility, management style, growth rate, and market conditions. 3) Business risk, tax rates, financial flexibility, management aggressiveness, growth needs, and market access all impact the optimal mix of debt and equity financing for firms.

1. FACTORS
AFFECTING CAPITAL
STRUCTURE DECISIONS
SUBMITTED BY:
AISWARYA.B
1st YEAR MBA
BRIM

2. CAPITAL STRUCTURE DECISION
 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. FACTORS DETERMINING CAPITAL STRUCTURE

4. Some of the Internal factors are:-
 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.
 Size of business: It is very difficult for small companies to raise long term debt.
Hence they depend on share capital and retained earning. A large company requires
large amount of capital. It cannot be raised from single source. Hence it has to rely on
different types of securities or sources at reasonable cost. A medium size company is
in a position to procure capital from all sources.
 Period and Purpose of Financing: Equity shares are the best choice for funds
required for permanent investment (long term). Debentures and preference shares are
preferable for medium term finance. Preference shares and debentures are better for
modernization and expansion.
 Asset Structure: The quantity of fixed asset and current asset in the total assets also
affect the capital structure. If a company has more fixed asset than current asset, it
will use more debentures and preference share and less equity share. On the contrary
if a company has more current assets, it may use more equity share capital.

5. Some of the Internal factors are:-
 Capital Market Conditions: Capital structure is also influenced by the conditions
of capital market. It determine the type of securities to be issued and also
determine the rate of interest of debentures, rate of dividend on preference share
etc. During depression, it is better raise capital through preference share and
debentures and during boom period equity shares are better .
 Cost of Financing: The cost of finance also exercise an important influence
upon the selection of securities. It is desirable to employ cheapest source of
finance to maximize returns. The cost of financing by debentures is cheaper than
financing by issue of equity shares.
 Statutory Requirement: While determining capital structure the company should
take care of the relevant provision of various laws framed by the government from
time to time. It should also take care of norms set by financial institution, SEBI,
stock exchange etc.
 Taxation Policy: High tax rate directly influences the capital structure decision.
High tax discourages the issue of equity shares and encourages the issue of
debentures. This is because the interest on debenture can be directly charged to
P/L account for tax calculation.

6. FACTORS MAINLY INFLUENCING CAPITAL
STRUCTURE DECISIONS
1. BUSINESS RISK
2. COMPANY’S TAX EXPLOSURE
3. FINANCIAL FLEXIBILITY
4. MANAGEMNT STYLE
5. GROWTH RATE
6. MARKET CONDITION

7. 1. BUSINESS RISK
 Excluding debt, business risk is the basic risk of the
company's operations. The greater the business risk, the lower
the optimal debt ratio.
 Uncertainty about future operating income (EBIT), i.e., how
well can we predict operating income?
 The business risk does not include financing effects.

8. BUSINESS RISK IS AFFECTED PRIMARILY BY:
Uncertainty about demand (sales).
Uncertainty about output prices.
 Uncertainty about costs.
Product, others types of liability.
Operating leverage

9. 2.COMPANY’S TAX EXPLOSURE
 Debt payments are tax deductible.
 Debt is not free either. Interest and fees paid to lenders form cost of debt –
the less is the cost the more debt can be used.
 One advantage of debt is that interest paid is deductible for the purposes of
calculating income tax. Therefore, the more debt is used the less is the
company’s effective tax rate.
 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.

10. 3.FINANCIAL FLEXIBILIY
 This is essentially the firm's ability to raise capital in bad times.
 Companies raising capital when sales are growing and earnings
are strong. Thus company's strong cash flow in the good times,
raising capital is not as hard.
 Companies should make an effort to be prudent when raising
capital in the good times, not stretching its capabilities too far.
 The lower a company's debt level, the more financial flexibility a
company has.

11. 4.MANAGEMENT STYLE
 Management styles range from aggressive to conservative.
 The more conservative a management's approach is, the less
inclined it is to use debt to increase profits.
 An aggressive management may try to grow the firm quickly,
using significant amounts of debt to ramp up the growth of the
company's earnings per share (EPS).

12. 5.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.
 More stable and mature firms typically need less debt to finance growth as
its revenues are stable and proven.
 These firms also generate cash flow, which can be used to finance projects
when they arise.

13. 6.MARKET CONDITION
 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.

14. CONCLUSION
 Thus every company needs capital to support its operations.
 Capital structure is a blend of company’s sources of finance and consists
of several types of funding.
 To be more specific, capital structure is a ratio of short-term, long-term
liabilities and equity.
 Depending on the sources of financing, we can distinguish borrowed (or
debt) capital and equity (owner’s capital).
 Combined they form company’s employed capital.
 Borrowed capital has some significant advantages.
 Interest paid is exempt when calculating profit for tax.
 Lenders receive only fixed income on provided funds and shareholder
doesn’t have to share profit with them.

15.  Can improve return on capital
 Harder to attract because lenders seek their own optimal risk-return ratio
 Lower company’s solvency
 Equity shares has some significant advantages i.e.
 Simplicity in raising (no approval needed, only owner’s decision)
 High rate of return on invested capital as interest on borrowed funds is not
paid
 Low risk of losing solvency and therefore lower risk of bankruptcy
 Equity is limited so it’s impossible to increase business size significantly
 Leverage is not used and total return is less than possible
 Thus the companies should consider the above factors while determining
the capital structure decision.