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Meaning and factors affecting Capital Structure

Meaning and factors affecting Capital Structure

Capital structure refers to how a company gets money to run its business and grow. It’s like a recipe that shows how much money comes from borrowing (debt) and how much comes from selling ownership (equity). A company’s capital structure affects how much risk it takes and how much it can grow, and it’s important to choose the right balance of debt and equity to be successful.

Capital structure refers to the mix of different sources of funds that a company uses to finance its activities. These sources can include borrowing money (debt), selling ownership shares (equity), or a combination of both. The way a company chooses to structure its capital can impact its financial health, risk level, and ability to obtain additional funding. Decisions about capital structure are important because they can affect a company’s ability to grow, its profitability, and its overall financial stability. The optimal capital structure for a company will depend on factors such as its industry, size, and risk tolerance.

Factors that affect a company’s capital structure can be broadly categorized into two groups:

Internal factors:

  1. Company’s growth plans: A company’s growth plans can affect its capital structure. If a company plans to expand its operations rapidly, it may require more capital and may rely more on debt to finance its growth.
  2. Profitability: A company’s profitability can affect its capital structure. A highly profitable company may rely less on debt financing and more on equity financing.
  3. Asset structure: A company’s asset structure can also affect its capital structure. A company with a lot of tangible assets, such as land, buildings, and equipment, may be able to borrow more money at a lower cost than a company with few tangible assets.
  4. Dividend policy: A company’s dividend policy can also affect its capital structure. If a company pays out a high percentage of its profits as dividends, it may need to rely more on debt financing to fund its growth.

External factors:

  1. Market conditions: The state of the capital markets can affect a company’s capital structure. If interest rates are low, a company may be able to borrow more money at a lower cost.
  2. Tax policies: Tax policies can affect a company’s capital structure. If debt financing is tax-deductible, a company may be incentivized to rely more on debt financing.
  3. Competition: Competition can also affect a company’s capital structure. If competitors are highly leveraged, a company may feel pressure to increase its own leverage to remain competitive.
  4. Industry norms: Industry norms can also play a role in a company’s capital structure. Some industries may have a tradition of relying more on debt financing than equity financing.

Ms. Kumari Priya

Assistant Professor

Department of BBA

kpriyaofficial1@gmail.com