After reading this article you will learn about capital structure. The more debt a company has, the more it has to pay creditors for the use of those funds. Abstract capital structure has been one of the most controversial issues in the field of finance during past years. In theory, it may be possible to reduce capital structure to a financial calculation to get the most tax benefits by favoring debt, for example, or to boost earnings per. Capital structure is expressed as debttoequity, or debttoinvested capital, where invested capital equals debt plus equity. It is the employment of an asset source of finance for which. Trading on equity means taking advantage of equity share capital to borrowed funds on reasonable basis. It includes equity share capital, reserves and surplus, preference share capital, loan, debentures and other such longterm sources of finance. The theory behind capital structure is to find the right mix of longterm funds that. To truly understand the idea of capital structure, the dupont model provides insight into how capital structure represents one of the three components in determining the rate of return a company will earn on the money its owners have invested in it. The study of capital structure attempts to explain how listed firms utilise the mix of various forms of securities in order to finance investment.
The theory and practice of corporate capital structure january 2006 2 liability strategies group executive summary this paper discusses the theory and practice of corporate capital structure, drawing on results from a recent survey. Capitalstructure is the most essential real time news and analysis service in the european distressed space. In section 2 the potential determinants of capital structure are summarized and theoretical and empirical evidence concerning these determinants is provided. To evaluate the interrelationship between capital structure and performance to determine the determinants of a capital structure 5. Reliance industries capital structure and theories of capital structure. Second, capital structure affects companys solvency key financial ratios like debt ebitda and debt equity are dependent on capital structure. Determinants of capital structure an empirical evidence, us by ra the university of lahore, pakistan. While determining capital structure, the following factors should be taken into account. The capital structure involves two decisions type of securities to be issued are equity shares, preference shares and long term borrowings debentures. Highly geared companies those companies whose proportion of equity. Capital structure, as its name itself signifies, is the composition of the capital employed by the firm from various sources of finance. Capital structure is referred to as the ratio of different kinds of securities raised by a firm as longterm finance. The capital structure is allowed to develop without any formal planning.
Effects of leverage on the shareholders return or earnings per share have already. Most favourable proportion determines the optimum capital structure. Capital structure is a permanent type of funding that supports a companys growth and related assets. A read is counted each time someone views a publication summary such as the title, abstract, and list of authors, clicks on a figure, or views or downloads the fulltext. Whether you own a donut shop or are considering investing in publiclytraded stocks, its the knowledge you simply musthave if you want to. The capital structure decision aswath damodaran stern school of business. Important factors in determining the capital structure of a. A companys capital structure refers to how it finances its operations and growth with different sources of funds, such as bond issues, longterm. Hence, theories of capital structure often assume some cost of bankruptcy that increases in debt, and derive optimal capital structure as the balance between the tax benefit and the bankruptcy cost. View 3a1 capital structure meaning and factors determining capital structure. Introduction capital is a critical resource for all firms, the supply of which is uncertain. Capital structure theory asks what is the optimal composition between debt and equity. Capital structure definition factors determining capital. Determinants of capital structure mba knowledge base.
Capital structure meaning and factors determining capital. Another factor determining a companys optimal capital structure is the debtequity ratios of other companies belonging to the same industry and facing a similar business risk. It is very difficult to pin point the factor which is highly responsible. Download project on capital structure file in pdf format. Factors affecting the capital structure of a company. The effects of firm size and risk on capital structure decisions of insurance industry in kenya michael njogu wahome, dr. Determinants of capital structure univerzita karlova. Capital structure means a combination of all longterm sources of finance. The capital structure should be such which increases the value of equity share or maximizes the wealth of equity shareholders. Important factors determining working capital requirements. Factors affecting capital structure decision of a firm are therefore critical. Feb 27, 2017 factors affecting capital structure 1.
What kind of capital structure is best for a firm is very difficult to define. Managing ventures capital structure 1 minimize cost of capital achieving the optimal mix of debt, equity and internal capital accessing low cost capital maximizes ventures value 2 raising capital is key to growth new ventures have large working capital and capex needs 3 maintain financial flexibility. These new findings add to the capital structure literature. As a matter of fact, capital structure planning is one of the major tasks which involve determination of the right proportion of different securities. There is a positive relation between the capital structure and size of a firm. Trading on equitythe word equity denotes the ownership of the company. Hypotheses the following hypothesis is formulated for the study h 0. Equity capital is the funds that the firms owners are trusting with the company and the retained earnings that represent profits from previous years, which are not distributed to the shareholders as dividends but are used towards the financing of debt or expansion of business. The paper contributes to the capital structure literature by investigating the determinants of capital structure of firms operating in the asia pacific region, in four countries with different legal, financial and institutional environments, namely thailand, malaysia, singapore and australia. The small companies often do not plan their capital structure. Capital structure while deciding the capital structure of the company the promoters will have to decide the proportion of capital to be raised by issue of shares and debentures. Analysis of capital structure is relevant to understanding the level of risk which a business has. Factors affecting capital structure decision of a firm. Capital structure definition capital structure definition capital structure of a company refers to the composition of debt and equity in a company.
For managing and survival of company, finances are very necessary. From the promotional stage to the end, it plays an. Mar 27, 2012 the factors influencing the capital structure or determinants of capital structure are discussed as follows financial leverage or trading on equity. Determining an optimum capital structure of an organization is obviously a crucial at all the time. The optimal capital structure should ensure companies retain sufficient capital levels. The capital structure puzzle is unravelled and a clear picture is presented in terms of why capital structure matters. Capital structure describes the amount of debt a company uses as opposed to equity, and it is often measured with the ratio of debt to equity. A companys capital structure points out how its assets are financed. Analyzing a companys capital structure investopedia. The theory of capital structure 299 tion of the relationships among similar models. Find capital structure definition and factors to be considered in its formulation process.
Which factors of capital structure decisions are important. In reality, it is difficult for companies to determine the best capital structure in an appropriate composition of spending. On the other hand, lubatkin and chatterjee 1994 as. An overview kennedy prince modugu department of accounting faculty of management sciences university of benin nigeria abstract capital structure decision poses a lot of challenges to firms. Also a conclusion can be given about the importance of the theories. The patterns of corporate capital structures around the world are also discussed. Factors that determine the capital structure among micro. Inequality capital structure that rests on the debt becomes worse when the load becomes high interest and depreciation of the rupiah. We have identified four categories of determinants of capital structure. Aug 30, 2014 factors determining financial structure of a company capital structure refers to the mixture of long term funds represented by equity share capital, preference share capital and long term debts. So while we may use the present capital structure as an approximation of the future, we really are interested in the companys analysis and resulting decision regarding its capital structure in the future. Determining the proportions of each source of capital. This article throws light upon the top seventeen factors determining the capital structure. Capital structure definition the capital structure is how a firm finances its overall operations and growth by using different sources of funds.
In section 1 the most prominent theoretical and empirical findings are surveyed. Factors determining financial structure of a company. Improper composition of capital structure could even lead the organization towards bankruptcy. The use of long term fixed interest bearing debt and preference share capital along with equity share capital is called financial leverage or trading on equity. One way of determining the right mix of capital is to measure the impacts of different financing plans. The vast majority of previous empirical works analyses the capital structure of firms in economies with highly developed stock markets. First, it examines a much broader set of capital structure theories, many of. Capital structure decisions in the biopharmaceutical industry. Here the data is described, measures of institute of economic studies, charles university, prague and idet, department of eco. Modigliani and miller proposed that capital structure is irrelevant when there are no taxes and that 100% debt is the optimal capital structure when there are taxes. The traditional school, at one extreme, argues that there is an optimum capital structure at which the value of the firm is highest.
That happens to be the need of the company because eps happens to be the maximum on it. When a company finances its operations by opening up or increasing capital to an investor preferred shares, common shares, or retained earnings, it avoids debt risk, thus reducing the potential that it will go bankrupt. Empirical evidence from kuwait ahmad mohammad obeid gharaibeh assistant professor, dept. The determinants of capital structure choice sheridan titman and roberto wessels abstract this paper analyzes the explanatory power of some of the recent theories of optimal capital structure. The results revealed that the use of debt financing by sri lankan firm is significantly low and this is largely due to the use of less long term debt. Trade off theory assumes that firms have one optimal debt ratio and firm trade off the. Decision regarding what type of capital structure a company should have is of critical importance because of its potential impact on profitability and solvency. Determinants of capital structure an empirical evidence, us. Some of the chief factors affecting the choice of the capital structure are the. Bahadur institute of management sciences, university of mysore, india available online at.
Key factors influencing capital structure decision and. Financial leverage is an important consideration in planning the capital structure of a company because of its effects on the earning per share. The effects of firm size and risk on capital structure. Pdf this note explores the interaction between the use of debt and firm value and provides a brief perspective on the use of debt. Theoretical considerations a firm could use three methods to determine its capital structure. Optimum capital structure and cost of capital n if the cash flows to the firm are held constant, and the cost of capital is minimized, the value of the firm will be maximized. It refers to additional profits that equity shareholders earn because of issuance of debentures and preference shares. The quantum of working capital is depending upon a large number of factors. Factors determining capital structure the capital structure of the business rely on many factors such as legal requirements, tax rate, business growth, business size, nature, leverage etc. Capital structure refers to the permanent financing of the company, represented by. There is a negative relationship between capital structure and financial performance.
Capital structure and its 4 important theories ni, noi. Anu1 master of business administration sastra university thanjavur,tamil nadu india this study is intended to find whether there is relationship between capital structure indicators bv, roa, roce, eps and mps and also to test the relationship between debtequity and. Under the capital structure, decision the proportion of longterm sources of capital is determined. In involves all the long term finances such as loans, shares, etc. Important factors in determining the capital structure of. If the financial statements, including the balance sheet, are audited, the. First, it determines which part of companys assets is funded by shareholders and which is attributable to lenders. What factors are important for capital structure decisions of dutch firms. The factors influencing the capital structure or determinants of capital structure are discussed as follows financial leverage or trading on equity. Irrelevance theorem a benchmark striking result is that under fairly general conditions, the value of the firm defined as the sum of value of debt and. The rationale here is that the debtequity ratios appropriate for other firms in a similar line of business should be appropriate for the company under consideration. The traditional school, at one extreme, argues that there is an optimum capital structure at. Capital structure is a statement of the way in which a companys assets are financed.
The capital structure of the firm represents its investment and financing strategy. Aswath damodaran 14 optimum capital structure and cost of capital n if the cash flows to the firm are held constant, and the cost of capital is minimized, the value of the firm. In other words, capital structure represents the proportion of debt capital and equity capital in the capital structure. A company has to decide the proportion in which it should have its own finance and outsiders finance particularly debt finance. Debt is equal to all interestbearing debt, which you can find on the balance sheet in the current liabilities and other liabilities sections. The large firms are more diversified, have easy access to the capital market, receive higher credit ratings for debt issues, and pay lower interest rate on debt capital. How to find capital structure using the balance sheet. 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. The degree of influence of each factor varies from time to time. Making capital structure support strategy mckinsey. Making capital structure support strategy the issue is more nuanced than some pundits suggest.
The factors that influence the capital structure are described below. Most of the results are in line with what was expected, except for the variables tangibility, free cash flow and priority shares. Determining an appropriate mix of equity and debt is one of the most strategic decisions public interest entities are confronted. Capital structure is the composition of longterm liabilities, specific shortterm liabilities, like bank notes, common equity, and preferred equity, which make up the funds a business firm uses for its operations and growth. Estimating the marginal cost of each source of capital. Willy muturi jomo kenyatta university of agriculture and technology. Therefore, accordingly, the main research question is summarized below. Capital structure theories the debate on optimal capital structure that leads to maximum market valuation and minimum cost of capital is perennial.
531 924 689 513 1566 1071 1483 743 692 1200 916 283 1275 738 233 932 265 1477 315 948 1132 377 1121 1268 1479 139 332 129 1612 1526 1374 240 1014 1194 620 834 237 937 901 699 1014 910 809 775 954 896 1020