Capital Structure is one of the financing decisions. It is a composition of a firms long term financing consisting mainly of equity, preference capital and long term debt i.e. mainly consists a mix of owner’s capital and borrowed capital. The decision is to make to collect the funds in the cheapest possible manner. In other words, the capital structure is how a firm finances its overall operations and growth by using different sources of funds.
It is a critical decision for any organization. It comes under the financing decision of the financial management. This decision is important because of the need to maximize returns to equity shareholders. It deals with best selection related to finance from large number of alternatives from where we can select our funds. It deals with long term funding requirement for more than one year. The capital structure of a company is the particular combination of debt, equity and other sources of finance that it uses to fund its long term financing. The key division in capital structure is between debt and equity. These decisions are strategic rather than tactical. Such decisions affect the profitability of a firm. They also have a bearing on the competitive position of the enterprise mainly because of the fact that they are related to fixed assets. Such decisions once made are not easily reversible. Thus factors which will help to design an optimal capital structure are:-
· Accept- Reject Criteria.
· Mutually Exclusive choice Criteria.
· Capital Rationing decision.
The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term debentures, while equity is classified as common stock, share holders equity. So it is a mixture of finance raised from equity share holders and long term debt. The makeup of the liabilities and stockholders' equity side of the balance sheet, especially the ratio of debt to equity. It should not be 100% equity neither 100% borrowed capital as this does not give good impact on our organization. So we have to determine optimum capital structure which is an appropriate mix which gives maximum profit to the equity shareholders. Some portion of capital should be borrowed in order to fulfill the objective of the financial management i.e. wealth maximization.
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