Meaning of Capital Structure:
Every business enterprise, whether big, medium or small, needs capital to carry on its operations smoothly and to achieve its targets. However, the actual capital should be neither more or less than the amount which is needed and gainfully employed. It is called capital structure of a business enterprise. Capital structure of a business enterprise is related to the long-term financial requirements of the business enterprise. It is determined by the long-term debt and equity capital used by the business enterprise. As a matter of fact, the capital structure of a business enterprise should be ideal, i.e., according to the requirement of the business enterprise.
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Determinants of Capital Structure:
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The following are the determinants or factors which determine the capital structure of a business enterprise:
Cost of Fixed Assets
The fixed capital of a business enterprise is invested in fixed assets. The fixed assets are not fixed in value; in fact, their value may record an increase or decrease in course of time. They are fixed in the sense that without them the business cannot be carried on. Further, they remain in business for a longer time. Hence, while making an assessment of the capital requirement the cost of fixed assets also be kept in mind.
Size of the Business Enterprise
The capital structure of a business enterprise is also influenced by the size of business enterprise. It may be small, medium or large. A large-sized business enterprise requires much more capital as compared to a small-sized business enterprise.
Nature of the Business Organisation
The capital structure of a business enterprise is also influenced by nature of business organisation. It may be manufacturing, financing, trading or public utility type.
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Retaining Control of the Business Enterprise
The capital of the business enterprise is also influenced by the intention of the promoters of having effective control. This is also a very important factor in deciding the capital structure. For this purpose they raise a large amount of money by issuing debentures and preference shares which hardly enjoy any voting rights.
Legal Requirements
One has to comply with the provisions of the law in regard to the issue of different types of securities. For example, in India banking companies are not allowed by the Banking Companies Act to issue any type of securities except shares.
Period of Finance
Period of finance, i.e., short, medium or long term is also another factor which determines the capital structure of a business enterprise. For example, short-term finances are raised through borrowings as compared to long-term finance which is raised through issue of shares, stocks etc.
The Purpose of Financing
The purpose of financing should also be kept in mind in determining the capital structure of a business enterprise. The funds may be required either for betterment expenditure or for some productive purposes. The betterment expenditure, being non-productive, may be incurred out of funds raised by issue of shares or from retained profits. On the contrary, funds for productive purposes may be raised through borrowings.
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Requirements of the Potential Investors
The capital structure of a business enterprise is also affected by the requirement of the potential investors. Different classes of investors go for different types of securities. Investors who are interested in the stability and safety and regularity of income prefer debentures and preference shares. On the contrary, investors who prefer to take risk so as to have higher income and also to take part in the management prefer shares or stocks.
Elasticity of Capital Structure
The capital structure of a business enterprise should be quite elastic so as to meet the future requirements of the capital also. For this purpose the amount of authorized capital should be fixed at a higher level as compared to present needs.
Money Market Conditions
Money market conditions also influence the capital structure of a business enterprise. In case of boom period it is advisable to issue shares which can fetch higher premium due to large profits. On the contrary, during the depression period it is advisable to issue debentures on account of lower rate of interest.
Miscellaneous
(i) Liquidity, (ii) Simplicity, (iii) Mutual rights, (iv) Policy of the business enterprises, (v) Capital gearing, (vi) Age of business enterprises.