Capital Structure: Find Capital Structure Definition and factors to be considered in its formulation process. In this article, you can find complete details for Capital Structure like the Meaning of Capital Structure, Capital Structure Gearing, Details for Highly geared companies, geared companies, Size of a company, Condition of economy, Condition of sales, Legal provisions, etc. Recently we have provided complete details onAccounting Rate of Return.
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Meaning Capital structure
Every business concern irrespective of its position whether big, medium, or small, or manufacturing or servicing whatever it could be, needs capital to carry on its operations smoothly and to achieve its objectives. However, the actual amount of capital required should be neither more nor less than the amount that is actually required and gainfully employed. Must Check Cash Basis Vs Accrual Basis of Accounting.
“Capital structure is the composition of different sources of funds like long-term liabilities, short-term liabilities like bank credit (overdraft), and preferred capital which make up the funds with which any business concern finances its assets and its day-to-day operations.”
Different sources of funds through which a company procures funds impose many restrictions on the company, thus ultimately they are to be selected after proper and adequate, appropriate planning and past experience.
Capital structure – Gearing :
Gearing is an indication of a company’s leverage in terms of its usage of equity funds and other debt sources. It’s an important concept that everyone should be aware of before thinking about their upcoming or current capital structure. Must Read Steps to Locate Errors.
From a capital structure point of view, we can classify the business entities into two different categories as
1. Highly geared companies :
If a business concern has more debt funds ( compared to equity ) in its total capital structure then it’s to be called a “highly geared company”.
2. Low geared companies :
If a company has more equity composition in its total capital structure that means it is a “low-gearing company”
Factors to be considered while determining capital structure :
1. Size of a company :
Generally, small companies procure required funds through loans, advances, and other short-term bank credits. Large companies having good reputations (goodwill) in the market obtain funds through equity issues, preference shares, and other long-term credits. Must Check Going Concern Concept.
2. Condition of the economy :
During a period of economic growth, a company can gather more funds if it issues shares in the primary market because there is a chance that the optimistic behavior of the public will make them purchase the shares at a high amount of premium, and this is not possible in case of downfall/recession of the economy.
3. Condition of sales :
If the company has stabilized sales which means its sales are either increasing or consistent trend then it can meet its fixed commitments like interest on debentures and bank loans, successfully. Otherwise, they have to go towards equity funds.
Must Read –Nostro Account and Vostro Account
4. Legal provisions :
Every entity depends on its form and should comply with many laws and regulations. For example, in India, there’s no practice of issuing irredeemable preference stock and banking companies should not procure funds through issues other than shares.
