Capital Structure – Meaning, Gearing, Factors for determining
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 Meaning of Capital Structure, Capital Structure Gearing, Details for Highly geared companies, Low geared companies, Size of a company, Condition of economy, Condition of sales, Legal provisions etc. Recently we have provided complete details on Accounting Rate of Return.
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Meaning Capital structure
Each and every business concern irrespective of its position whether big, medium or small, or manufacturing or servicing what ever 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 which is actually required and gainfully employed.
“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 today 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 every one should be aware before thinking about their upcoming or current capital structure.
From 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 as “highly geared company”.
2. Low geared companies :
If a company has more equity composition in its total capital structure that means it is “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.And large companies having good reputation (goodwill) in the market obtain funds through equity issue ,preference shares and other long term credits.
2. Condition of economy :
During the 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 behaviour of public will make them to purchase the shares at high amount of premium ,and this is not possible in case of down fall/recession of economy.
3. Condition of sales :
If the company has a stabilized sales which means it’s sales are either in increasing or consistent trend then they can meet their 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 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 issue of other than shares.