Capital is the essential requirement to run an organization successfully. One needs capital from the very start of their business. Here, finance manager has to take correct steps to allocate capital investment precisely with the help of forecasting. This helps in maintaining the capital investments and other funds in different forms.
It is defined as the total sum of the capital for a company that is the conversion of their investments at every stage.
According to one of the experts, A. S. Dewing, “Capitalization is defined as the valuation of capital. It includes capital stock and debt as well.”
Another expert, Gerrtenbeg has defined the statement for Capitalization as, “The total financial value of capital for all practical operations that is employed in the business is considered as Capitalization.”
What is Capital Structure?
To obtain fund from the market, a company issues different securities as investments such as ordinary shares, bonds, debentures and preference shares. This number of investments issued by the company is listed as Capital Structure.
Gerrtenbeg defined Capital Structure as the make-up of Capitalization. It is also termed as Financial Structure.
According to Weston and Brighan, “Considering the preferred stock, net-worth and long-term debt, Capital Structure is financing of the firm.”
Factors that Affect Capital Structure:
Several factors that are responsible to put an effecton any company’s Capital Structure that include:
- Legal Restrictions:
Whether it is Corporate Institute or Commercial Institute, every company is restricted to some extent with the laws regarding their issue of securities. Especially in India, promoters have to follow certain provisions as the banking sector is only allowed to issue securities of equity shares.
- Period of Finance:
It determines one’s Capital Structure. The period of finance can be met through usual borrowings for short-term achievements. But when the fund is required for more than 8 years, there is a need for issuing debentures. There are cases when the need for issuing of equity shares is required for funding more than 10 years.
- Nature of Enterprise:
The financial structure of an institute varies according to the nature of business. Similar businesses can have varying income statistics that regulate the risk level. If the organization is engaged business that supports public utility services, then it mostly prefers issuing equity and debentures.
- Size of the Company:
Sizeof the company matters in handing funds!Here, small-scale organizations find difficulties when they require long-term debts. Considering the same fact for large-scale organizations, these are having less risk as they get easy borrowing from different sources.
- Market Conditions:
As per the market trend, Capital Structure of a company gets changed. Investors like to invest more when the market moves in positive direction. If the condition gets reversed, then investors look for finding safety measures. At this time, they start investing in debentures rather than equity shares.
- Government Policy:
If there is any change in monetary fund, financial policies or fiscal, it affects Capital Structure of a company. Here, proper decision is required to maintain financial balance of the company to match-up the statistics with upcoming changes. In this context, any change in provision of the SEBI affects investment policy of the company as well.
- Trading on Equity:
Issuing shares or debentures help in the mobilizing the capital of a company. Here, the rate of return is always greater than the total amount of investment if it has been done precisely. This is termed as trading on equity. Hence, a company gets ahigher rate of earnings that help in less investment of capital. This is one of the major benefits of trading on equity.
- Purpose of Financing:
A company should keep in mind that the purpose of financing is to maintain proper balance of investment and earnings. While formulating the Capital Structure, the company can raise their funds through equity shares. For direct productive purposes, the organization should go for issuing debentures.
- Cost of Capital and Availability of Funds:
With the knowledge of cost of capital, any company is able to maintain their financing appropriately. Availability of funds needs the study of various types of financing in terms of capital investment to check availability of alternatives and maintain the level of risk. This then determines the financial position of the company.
- Need of Investors:
The psychological attitude of different investments is one of the major concerns to maintain the Capital Structure. Some prefer to invest in equities and others prefer debentures. In this context, debenture investors have low risk because of stable income statistics whereas equity investors have higher risks along with higher rate of returns.
Basic Patterns of Capital Structure:
- Issuing equity shares only
- Issuing equity shares along with preference shares
- Issuing equity plus debentures
- Issuing equity shares plus preference shares plus debentures
Capital Structure is thus, important to maintain properly in an organization by finance manager.