Factors Affecting Capital Structure of a Company
Factors affecting a firm's choice of capital structure are given in the diagram below: ↓
Factors influencing capital structure of a firm are follows:
- Trading on Equity
- Desire to Retain Control
- Size of Company
- Nature of Business
- Amount of capital Required
- Cost of Financing
- Growth Rate
- Period of Finance
- Attitude of Lenders
- Purpose of Financing
1. Trading on Equity
Important Factors affecting capital structure of a company are trading on equity. Trading on equity are the arrangement made to the enterprise to use borrowed funds. These borrowed funds carrying a fixed rate of interest. They are planned in such a way to increase the rate of return on equity shares. Since the preference and debentures carry a fixed return, the companies will operate with a low equity base and borrow more funds, by the way, of external borrowings.
2. Desire to Retain Control
The main factors that are affecting capital structure of a company are desire to retain control. The promoters may desire to retain a substantial control over the management within the company. The promoters may seek more of debt financing rather than issuing shares to the public. The debt financing rather consists of debentures, preference shares as such shares do not have normal voting rights.
3. Size of Company
Factors influencing a capital structure of the company are size of the firm. Small companies depend more on owned funds rather borrowed funds. As it finds difficult to obtain long-term loans from financial institutions and banks due to lack of adequate security.
4. Nature of Business
Factors affecting capital structure of a company is nature of business. Companies which are assured of stability, and growth may go for borrowed capital funds as they can pay interest regularly. If the company is of cyclical in nature, then it may go for equity capital than debt financing.
5. Amount of Capital Required
Factors affecting capital structure of a company is the amount of capital required by the firm. If the amount of capital required is less, it can be collected from equity shareholders or by way of borrowed funds. However, if the funds required are large, then the company has to attract different types of investors.
6. Cost of Financing
Factors affecting capital structure of a company is the cost of financing. The company must collect funds at the lowest possible cost. Generally, the cost of collecting money through debentures and bonds is relatively less as compared to the cost of collecting funds by Equity.
7. Growth Rate
Factors affecting capital structure of a company are the growth rate of finance. The financial requirements of growing firms are high and cannot be met from internal sources. The financial requirements of growing firms are high and cannot be met from internal sources. They have to depend heavily on external financing. Thus, such firms rely more on debt capital.
8. Period of Finance
Factors affecting capital structure of a company are the term of finance. If the funds are required for a short period, the company may rely on debentures and fixed deposits. However, if the funds are required for a long period, then the company can go for equity capital.
Factors affecting capital structure of a company are flexibility within the firm. If the firm has an ability to raise capital from any source, then it would be advisable to go for borrowed funds rather than more equity. However, the firm must be able to pay interest and installments on time.
Factors affecting capital structure of a company are profitability to the firm. Firms which are highly profitable use little debt as their fund's requirement can be met from internally generated funds or by retained earnings.
Factors affecting capital structure of a company are timings. Capital Markets go through a cyclical pattern, i.e. boom, recession and recovery. During boom period, investors prefer equity. There are chances of collecting equity at a premium. During recession, investors are not inclined towards equity; they prefer debentures and fixed deposits.
Factors affecting capital structure of a company are taxes laid on the firm.
13. Attitude of Lenders
Factors affecting capital structure of a company are taxes laid on the firm. The interest on debt-capital is a tax-deductible expense, whereas dividend payment is not so. hence, higher the tax rate, greater the incentives to employ debt capital.
14. Purpose of Financing
Factors affecting capital structure of a company are the purpose of financing. If the funds are required for purchasing new machinery, then the company may raise money through debentures or term loans, as the company may be able to pay interest on debentures out of profits generated due to use of machinery.