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.

Corporate Finance- Making Simple

The main objective of financial management is to arrange sufficient finances for meeting short-term and long term needs. These funds have to be procured at minimum costs so that profitability of the business can be maximized.

Here are some simple steps that can be followed to manage the finances of a corporate

Estimating Financial Requirement

This is the foremost task to determine the short term and long term needs of finance on the basis of its strategic importance. Such an estimate must be screwed to perfection since shortage of funds would have an adverse effect and excess funds may lead in extravagant spending, speculative activities and rising interest figures.

Selecting sources of finance

There may be as many sources of finances such as shares, debentures, financial institutions, banks and public deposits. If funds are required on a long term basis then shares and debentures may help the cause. Financial institutions and banks can be used to finance on a short term need.
If the management does not want to tie its assets then public deposits may used as a source to finance.

Selecting a Pattern of Investment

After the finances are available it becomes very necessary to allocate it properly. Finances must be first allocated to procure fixed assets(Plant and Machinery) and then the remaining must be allocated to meet the working capital requirements(Day to day working requirements like wages, bills etc). Proper techniques like cost-benefit analysis and opportunity costs analysis must be followed before a capital investment.

Proper Cash Management

Cash may be required to purchase raw materials, pay creditors, wages, utility bills etc. Inadequate cash may hamper the production cycle or may limit the scope of some attaining seasonal and contingent advantages. Excess cash may cause funds to remain idle and increasing the cost of capital by rising Interest charges. Hence proper cash management becomes a must by maintaining balance between cash inflows and cash outflows.

Implementing Financial Controls

Various control Devices and techniques must be used in ordinary course of business to monitor the usage of finances. These devices are return on investment, budgetary control, break even analysis, cost control, ratio analysis and cost and internal audit.
Return on investment is taken as the best measure in many corporate

Proper use of Surplus

To gain maximum growth judicious use of surpluses becomes a must. Surplus can be used in diversification, expansion and to declare dividends that would satisfy shareholders and eventually helps in raising market prices of shares.
Ploughing back of profits may be used to finance expansion and diversification but may go against the interest of shareholders. So an optimum balance has to be carved out between the two options.

This simple process is used by businesses to grow into corporate.