Factors affecting capital structure

factors that affect capital structure

1. FACTORS AFFECTING CAPITAL STRUCTURE SANDEEP S

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.

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