- Capital structure of a firm is a reflection of the overall investment and financing strategy of the firm.
- Capital structure can be of various kinds as described below:
▪ Horizontal capital structure: the firm has zero debt component in the structure mix. Expansion of the firm takes through equity or retained earnings only.
▪ Vertical capital structure: the base of the structure is formed by a small amount of equity share capital. This base serves as the foundation on which the super structure of preference share capital and debt is built.
▪ Pyramid shaped capital structure: this has a large proportion consisting of equity capita; and retained earnings.
▪ Inverted pyramid shaped capital structure: this has a small component of equity capital, reasonable level of retained earnings but an ever-increasing component of debt.
SIGNIFICANCE OF CAPITAL STRUCTURE:
- Reflects the firm’s strategy
- Indicator of the risk profile of the firm
- Acts as a tax management tool
- Helps to brighten the image of the firm.
FACTORS INFLUENCING CAPITAL STRUCTURE:
- Corporate strategy
- Nature of the industry
- Current and past capital structure
CAPITAL STR. V/S FINANCIAL STR.:
1. CS relates to long-term capital deployment for creation of long-term assets. FS involves creation both long term and short term assets.
2. CS is the core element of the financial structure. CS can exist without the current liabilities and in such cases; CS shall be equal to the financial structure.
3. FS of a firm is considered to be a balanced one if the amount of current liabilities is less than the capital structure net outside debt because in such cases the long-term capital is considered sufficient to pay current liabilities in case of sudden loss of current assets.
4. Components of the...