What is Capital Structure?

What is Capital Structure?

Capital is the most important aspect of launching a business. It serves as the company’s foundation. The two basic types of financial sources for a firm are debt and equity. The capital structure of a corporation is described as the combination of equity and debt used to finance the company’s overall operations and growth.

Capital Structure

Capital structure is defined as the structuring of capital through the use of various long-term finances, which are divided into two categories: equity and debt. Preference shares, equity shares, retained earnings, long-term loans, and other types of funds are raised by a company. These funds are raised to help run the business.

Types of Capital Structure

Equity Capital

The money owned by the shareholders or owners is referred to as equity capital. It is divided into two categories.

a) Retained earnings: Retained earnings are a portion of a company’s profit that is held separately and used to strengthen the business.

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b) Contributed Capital: Contributed capital is the amount of money that the company owners invested when the company was founded or received from shareholders as a price for ownership of the company.

Debt Capital

Debt capital is defined as borrowed money used for business purposes. There are various types of debt capital.

a) Long Term Bonds: These bonds are the safest of debts since they have a long payback duration and just interest must be returned while the principle must be paid at maturity.

b) Short Term Commercial Paper: This is a form of short-term financial instrument used by businesses to raise funds for a limited time.

Hybrid Financing

Hybrid financing incorporates both stock and debt. It covers financial instruments that have both equity and debt features.

a) Bonds that can be converted into a predetermined number of shares of common stock at a later period are known as convertible bonds.

b) Preferred Convertible Stock: Preferred stock with a predetermined conversion ratio that can be converted into common stock.

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Mezzanine Financing

Mezzanine financing is a type of financial financing that combines debt-like qualities with equity choices. It is frequently utilised to fill the void between senior debt and equity funding.

Importance of Capital Structure

 

Capital Structure

A firm’s capital structure is critical since it determines the firm’s overall stability. Here are some more considerations that emphasise the significance of capital structure.

1.A company with a strong capital structure has a better possibility of raising the market value of its shares and securities. It will result in a greater market valuation.

2.A sound capital structure guarantees that available funds be utilised wisely. It prevents excessive or insufficient capitalisation.

3.It assists the organisation in growing earnings through increased returns to stakeholders.

4.A suitable capital structure assists in maximising shareholder capital while limiting overall capital costs.

5.A sound capital structure allows enterprises to increase or decrease debt capital depending on the situation.

Factors Determining Capital Structure

 

Capital Structure

Following are the factors that play an important role in determining the capital structure:

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1.Capital costs: These are the expenses incurred when raising funds from various sources. A firm or business should earn enough revenue to cover the cost of capital and finance growth.

2.Degree of Control: In a firm, equity shareholders have more rights than preference or debenture shareholders. The type of shareholders and the limits on their voting rights will establish a company’s capital structure.

3.Trading on Equity: A firm that borrows fresh funds to boost returns by using more equity as a source of finance. When the rate of return on total capital exceeds the rate of interest paid on debentures or the rate of interest on additional debt acquired, trading on equity is said to occur.

4.Government Policies: The capital structure is also influenced by the government’s rules and policies. Changes in monetary and fiscal policy cause changes in capital structure decisions.

 

Conclusion: In this article we learn That  What is Capital Structure?, Types of Capital Structure, Importance of Capital Structure and Factors Determining Capital Structure.This Article Is Very Important For All students who adopt ‘Business’ Subject.

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