Capital Structure

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The Capital Structure of a Company

Capital structure is finding out the right arrangement of the various components of business funds that can help a company run without a problem and meet its funding requirements for the daily expenses and long-term future projects. When it comes to finding the perfect capital structure, you need to take help from analytics, mathematical formulas, strategic thinking and company’s expenditure to find the right balance between the capital structure and the expenses of a company.

Factors That Forms Capital Structure

The business can be easily affected by both the internal and external environment. Given below, we have pointed out some of the leading factors which play a vital role in defining the capital structure of a company.

  • Nature of business 

  • Debt-equity ratio

  • Size of the company

  • Risk of cash insolvency

  • Flexibility

  • Future provisions

  • Degree of control

  • Legal requirements

  • Tax rates

  • Sales stability

Components of Capital Structure

Capital structure is a method to find out possible components of business funds. These can be your shareholder's funds and the funds which the company has borrowed in proper proportion. A company or business utilizes the funds to meet its everyday expenses and requirements. Likewise, these funds are used for budgeting high-end future projects. There are several component combinations that a company uses to form its capital structure. Given below, we have listed all the essential capital structure elements you need to have in your strategy.

Equity Capital - In this case, the owner shares both the loss and the company's profit according to the dividends in a proportion of their profits. The new shares are given in the form of equity shareholders, and once they get it, they get to enjoy the company's ownership. 

Preference Capital - These shareholders enjoy a fixed rate of dividends in addition to the preferential rights of getting the profit in return for the capital, which they have invested in case the company goes under liquidation. When you compare the equity capital with the preference capital, they don't have the full authority over the company's decision-making. As a result, they have limited rights when voting is needed for the decision to settle up. 

Retained Earnings - This is a kind of piggy bank for companies when they need to spend some amount on their future projects or to grow their business. Companies tend to take money and funds from the retained earnings. 

Debentures - These types of funds come under the borrowed funds; this is a debt instrument that both the companies and the government issue to the public in the market. In this, the rate of interest is relatively higher than a typical debt on debentures. On the other hand, these dentures don't need any collateral or security for the funds. 

Term Loan - This is the type of loan which a company acquires from the bank at a floating or a fixed interest rate. If your company is in a great financial position and it is eligible for the bank loan, then without a doubt, you need to go with loans. 

Public Deposits - When a company is asking for an available deposit, it means is to invite the public through various advertisement funnels and make them create a deposit in the company. The company can use this deposit to meet its medium and long-term financial needs for current and future projects. On this type of deposit, the depositors get a fixed rate of interest. 

FAQs (Frequently Asked Questions)

1. What is the Capital Structure in Financial Management?

To manage its growth and overall operations, companies make a financial path for the company to follow, which is a combination of debt and equity. Debt for the company can come in the form of bonds which the company issues or loans. On the other hand, if we are talking about equity, it can come from common stock, preferred stock, along with short term debts. All of these can be termed as capital structure. In payment terms, it is how companies fund their overall operation and their roadmaps for the financial year, keeping the company's growth in mind.  

2. How Capital Structure Helps in Creating Greater Control and Flexibility?

If you want to have full ownership of your business, you need to work on your debt financing. When you have full ownership of a company, you get full control, which allows you to make crucial decisions all by yourself. As a result, the equity investors get a small portion of the company's earnings, depending on the stock they have bought. In addition to this, debt investors need to be paid no matter what. If a company fails to pay them, it will come in default.