Factors determining Capital Structure

Topics: Finance, Stock, Capital structure Pages: 5 (1612 words) Published: March 16, 2014
Capital Structure: The most important function of Financial Management is to make decisions about the capital structure of firm. Capital structure refers to the make up a firm’s capitalization. It represents the mix of different sources of long term funds in the total capitalization of the company like equity shares, preference shares, retained earnings, long-term loans etc. In other words it can be precisely told as financing plan of the company. Capital is required to finance investments in plant and machineries, inventory, accounts receivable and so on. A finance manager has to choose the most appropriate source of financing these activities from various sources available like equity, preference shares, debenture stock, term loans from banks or financial institutions, short term borrowings, supplier’s credit etc. The various factors determining the capital structure of a firm are as follows, a)Leverage or Trading on equity

b)Retaining control
c)Nature of the enterprise
d)Size of the company
e)Purpose of financing
f)Period of finance
g)Market sentiments
h)Cost of capital
i)Cash flow projections of the company
j)Government policy
k)Requirements of investors
l)Legal requirements
A company may raise funds from different sources such as equity shares, preferences shares, debentures, term loans etc. The use of these fixed charge sources of funds in the capital structure is known as financial leverage or trading of equity. Capital structure is mainly influenced by the factor retaining control. The question of who will be having the control of fund management mainly affects the capital structure. Based on this factor the capital structure largely differs from one firm to another. In case if the company decides to retain the complete control of capital within the firm, then capital structure changes accordingly. Nature of enterprise also influences the capital structure. In case of public enterprises the funds or finance or capital will be raised through share markets or from government funding. Other enterprises may be raising the funds through other sources. Hence, the nature of enterprise influences the capital structure mainly. At the same time like the nature of enterprise, the size of the company also influences the capital structure. In case of large and very large enterprises the funds or finance or capital will be raised through share markets. But in the case of small and medium enterprises the capital would be raised from different sources other than the share markets hence there would be a huge change in capital structures. Financial structure refers to the way the firm’s assets are financed. It includes both the long term as well as short term sources of funds. Capital structure on the other hand is the permanent financing of the company represented by long term debt and share holder’s funds by excluding all short term credit. This means, that a company’s capital structure is only a part of its financial structure. Hence long term source of funds forms the major part of capital structure. Purpose of financing is a major factor in capital structure. The purpose of financing like investment in plants and machineries, inventory and others influence the change in capital structure. Period of finance forms one of the major factors in capital structure. The period of financing might vary from short term to long term. Financial structure might have both short and long term financing, but capital structure consists of only the long term financing. Within this long term it can further segregated as more than a year and less than three years, more than three years and less than five years, more than five years and less than ten years, more than ten years of long terms. Thus the period of financing in capital structure influences it much. Market sentiments also affect the capital structure. In case of firms raising the funds from share markets gets largely affected by means of changes in stock market...
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