Capital Structure – Determinants

Capital structure means a mix of company’s long-term debt, specific short term debt, common equity and preferred equity.
Capital structure is how a firm finances its overall operations and growth by using different sources of funds.

There are many factors that affect the capital structure such as trading on equity, sales, nature and size of firm, cost of capital, requirements of investors etc.


Growth and stability of sales
As far as a firm enjoys growth or stability in sales it could include long term debt or can employ debt financing. Constant sales indicate company’s healthy cash flows and its ability to pay the interests and the debt as well. Where sales are fluctuating debt financing is not a good option.


Nature and size of firm
Normally public utility undertakings employ long term debt due to stability in earnings.
Whereas manufacturing concern has to heavily on equity due to inherent trait of extending sales on credit. A small concern has to bring owned funds as it becomes very difficult for the concern to float equity in public.



Cost of capital

Every single dollar counts. Investor expects return on every cent they invest in the company, may be in the form of credit or purchasing equity shares.
Debt serves as the cheapest source of financing but has a fixed and legal obligation to pay the interest amount. Whereas equity is the most expensive source of financing but the company has no obligation to pay the dividends.
So the cost of raising such a capital has a large bearing over the capital structure.

Capital market conditions
Capital market condition does not remain stable for long and it keeps on fluctuating. There may a depression or a boom. When the share market goes down the company has to employ debt financing to serve the interest of its stock holders and vice-a versa.

Corporate tax rate
High rate of corporate tax on profits compel companies for debt financing because interest is allowed to be deducted while calculating taxable profits and on the other hand dividend is not an allowable expense in that purpose.

Aims of financial functions

The primary aim of finance function is to arrange as much funds for the business as are required from time to time and manage funds in such a way so as to ensure their optimum utilization and their procurement in a manner that the risk, cost and control considerations are properly balanced in a given situation.

Acquiring sufficient funds

The main aim of finance function is to assess the financial needs of an enterprise and the finding out suitable sources for raising them. The sources should be commensurate with the needs of the business.

Proper utilization of Funds

The funds should be used in such a way that maximum benefit is derived from them. The returns from their use should be more than their cost. It should be ensured that funds do not remain idle at any point of time. Those projects should be preferred which are beneficial to the business.

Increasing Profitability

It is true that the money generates money. To increase profitability, sufficient funds will have to be invested. Finance function should be so planned that the concern neither suffers from inadequacy of funds nor wastes more funds than required. The proper control should also be exercised so that the scarce resources are not frittered away on uneconomical operations.

Maximizing Firm’s value

Finance function also aims at maximizing the value of the firm. It is generally said that a concern’s value is linked with its profitability. Even though profitability influences a firm’s value but it is not all. There are some other considerations which also influence a firm’s value like the condition of money market, the cost of funds etc.

An effective finance function, which includes all aspects of finance, tax, and treasury and, typically, risk management, makes a positive contribution to the achievement of the organization’s strategic objectives and to its value creation goals.

Factors influencing size of receivable

Receivables represent the amounts owed to the company as a result of sales of goods and services in normal course of business. These are the claims of the firm against customers and form a part of current assets. Receivables are also termed as account receivables, customer receivables, trade receivables or book debts.





Size of credit sales

The volume of credit sale is the first factor that influences receivables. Firm adhering to cash sales would have low receivables when compared to firms allowing sales on credit.
Higher the credit allowed more will be the receivables and vice a versa

Credit Policies

Firm with conservative credit policies will have low receivables when compared with firms following liberal credit policies. The vigour with which the concern collects the receivables also affects the size of its receivables. Prompt collections even with liberal credit policies will help in keeping receivables under control. Outstanding for long period may result in bad debts.

Terms of trade

The period for which the credit is allowed will decide the extent of receivables. Longer the period of credit more would be the receivables. Again, cash purchases followed up with credit sale is the main reason for increasing receivables.

Expansion plans
Concerns that want to expand has to enter new markets. To attract customers it becomes necessary for the enterprise to provide incentives in terms of credit. Once the concern gets the permanent customers it may start reducing the period for which credit was allowed.


Credit collection efforts
A concern should always have strong and well equipped credit collection machinery.
Periodical reminders should be sent to customers in order to reduce the size of outstanding. Delayed collection will increase receivables and will impose serious financial troubles for the company.

Dividend Policy- Determinants

Dividend is that part of profit that is distributed among the shareholders of the company .
The payment of dividend includes legal and financial formalities. It is difficult to determine general dividend policy which can be followed by a firm at different situations.


Magnitude of earnings
As dividend can be paid out of present and past earnings, trend and magnitude of earning becomes the starting point of consideration. Moreover retained earnings of the past generally go in investment and hence the amount of profit determines the dividend policy.



Future financial requirement
Dividend policy is also affected by firm’s future capital needs. Funds are required for diversification, expansion and tapping new opportunities. Firm looking out for such options may retain profit and may neglect announcing dividends for the current year.

Income tax
Dividend policy is tremendously affected by the income tax regulations. Income tax may affect the total profit of the company leaving behind a very small amount to be declared as dividend. Moreover if dividend income of the shareholders is heavily taxed the company may not announce dividends on a regular basis in order to safeguard the interests of its share holders.
Age of the company
A newly established business may not declare dividends as its major objective would be to increase the retained earnings that can be used at future period of time.Declaring dividend will result in lack of liquid resources which can limit the establishment in taking advantages of upcoming opportunities. Where as an old establishment can follow a liberal dividend policy because of its piled up profits from the past.

Liquid resources
Dividend can be paid out only when the firm has full control of its liquid resources like cash, marketable securities etc. Lack or requirement of liquid resources in near future goes up in deciding the type of dividend that has to be declared.

Institutional investors
The firm has also to keep in consideration the demands of its institutional investors which helps it time and again. Institutional investors like bank, financial houses etc generally favors a regular payment of cash dividends. Since these investors play a pivotal role in providing financial aid to the company, the company has to mould its dividend policy accordingly.