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.
Posts
No comments:
Post a Comment