financial structure refers to the composition of sources and amount of funds collected to use or invest in business. in other words financial structure refers to the capital and liabilities side of balance sheet. so it includes shareholder's funds long-term loans as well as short-term loans it is different from capital structure as capital structure includes only the long term sources of financing while financial structure includes both long term and short term sources of financing. financial structure can mainly be subdivided into ownership financing and borrowed financing ownership financing includes equity share capital and reserve and surplus. joint stock company cannot be established with co equity financing. in Nepal the promoters must hold at least one share for the incorporation of joint stock company in accordance with company act 2053. borrowed financing includes short debt and term loans as well ass the varieties of bond or debentures. preferred stock in nether purely a debt nor a equity. since it contains the characteristics of both debt and equity. it is called a hybrid security. so, there is no unanimous practice about the treatment of preferred stock . however it is said to be equity from legal point of view since the company is not obliged to pay dividends on preference shares.
following factors should be taken in to consideration while designing the capital structure or financial structure.
1.structure or financial structure
firms whose sales are relatively stable can use more debt and incur higher fixed charges than a company with unstable sales. as far as growth rate is concerned. other things remaining the same faster-growing firms must rely more heavily on external capital. thus, rapidly growing firms tend to use some what more debt than slower growing companies.
2.cost of capital
as discussed above optimal capital structure should be less costly. therefore, company should use the sources having lower cost. component cost of capital is compress of using costs and issuing costs. hence, flotation cost of various kinds of securities should also be considered while raising funds. the cost of floating a debt is generally less than the cost of floating equity and hence it may persuade the management to raise debt financing.
3.asset structure
firms whose assets are suitable as security for loans to use debt rather heavily. general-purpose assets, which can be used by many business male good collateral where as special purpose assets do not thus, real state companies are usually highly leveraged, whereas companies involved in technological research employ less debt.
4.management attitude
some management tends to be more conservative than other, and thus use less debt than the average firm in their industry, where as aggressive management use more debt in the quest for higher profits. however, if too little debt is used, management runs the risk of a takeover. thus, control considerations could lead to the use of either debt or equity, because the type of capital that best protects management will very from situation to situation.
5.lender attitudes
lender attitude frequently influence capital structure decisions. lenders emphasize that excessive debt reduces the credit standing of the borrower and the credit rating of the securities previously issued. the corporation discusses. its financial structure with lenders and gives much weight to their advice. if management wants to use leverage beyond norms for the industry , lenders may be unwilling to accept such debt increases.
6. operating leverage
other things remaining the same a firm with less operating leverage is better able to employ financial leverage. interaction of operating and financial leverage determines the overall effect of a change in sale on operating income and net cash flows.
7. taxes
interest is a deductible expense, and deductions are most valuable to firm with high tax rates. hence, the higher a firms corporate tax rate, the greater the advantage of debt.
8.profitability
firms with high rate of return on investment use relatively little debt. for example, Intel, Microsoft and coca-cola simply do not need to use much debt. their high rate of return enables them toe do most of their financing with retained earning.
9. interest rates
at certain point of time, when the general level of interest rates is low the use of debt financing might be more attractive when interest rates are high , the sale of stock may become more appealing.
10. control
the effect of debt versus stock on a management's control position can influence capital structure, if management currently has voting control, but is not in a position to buy any more new stock, it may choose debt for new financing . on the other hand , management may decide to use equity if the firms financial situation is so weak that the use of debt might subject it to serious risk of default because, if the firm goes in to default, the managers will almost surely lose their jobs. however, of too little debt is used management runs the risk of a takeover. thus, control considerations could lead to the use of either debt or equity.
11. flexibility
capital structure of a firm should be flexible i.e., it should be such as to be capable of being adjusted according to the needs of the changing conditions. it should be possible to raise additional funds whenever the need be, without much of difficulty and delay. a firm should arrange its capital structure in such a manner that it can substitute one form of financing by another.
12. nature and size of the firm
nature and size of a firm also influences its capital structure. a public utility concern has a different capital structure as compared to other manufacturing concerns. public utility concerns may employ more of debt because of stability and earning due to the nature of the business will have to rely mainly upon owned capital as it is very difficult for then to raise long term loans at a reasonable rate of interest, while a large company can arrange long term loans at reasonable terms and also can issue equity and preference share at case to the public.
13. legal requirements
the government has also issued certain guidelines for the issue of share and debentures. the legal restrictions are very significant as these lay down a framework with in which capital structure decision has to be made.
following factors should be taken in to consideration while designing the capital structure or financial structure.
1.structure or financial structure
firms whose sales are relatively stable can use more debt and incur higher fixed charges than a company with unstable sales. as far as growth rate is concerned. other things remaining the same faster-growing firms must rely more heavily on external capital. thus, rapidly growing firms tend to use some what more debt than slower growing companies.
2.cost of capital
as discussed above optimal capital structure should be less costly. therefore, company should use the sources having lower cost. component cost of capital is compress of using costs and issuing costs. hence, flotation cost of various kinds of securities should also be considered while raising funds. the cost of floating a debt is generally less than the cost of floating equity and hence it may persuade the management to raise debt financing.
3.asset structure
firms whose assets are suitable as security for loans to use debt rather heavily. general-purpose assets, which can be used by many business male good collateral where as special purpose assets do not thus, real state companies are usually highly leveraged, whereas companies involved in technological research employ less debt.
4.management attitude
some management tends to be more conservative than other, and thus use less debt than the average firm in their industry, where as aggressive management use more debt in the quest for higher profits. however, if too little debt is used, management runs the risk of a takeover. thus, control considerations could lead to the use of either debt or equity, because the type of capital that best protects management will very from situation to situation.
5.lender attitudes
lender attitude frequently influence capital structure decisions. lenders emphasize that excessive debt reduces the credit standing of the borrower and the credit rating of the securities previously issued. the corporation discusses. its financial structure with lenders and gives much weight to their advice. if management wants to use leverage beyond norms for the industry , lenders may be unwilling to accept such debt increases.
6. operating leverage
other things remaining the same a firm with less operating leverage is better able to employ financial leverage. interaction of operating and financial leverage determines the overall effect of a change in sale on operating income and net cash flows.
7. taxes
interest is a deductible expense, and deductions are most valuable to firm with high tax rates. hence, the higher a firms corporate tax rate, the greater the advantage of debt.
8.profitability
firms with high rate of return on investment use relatively little debt. for example, Intel, Microsoft and coca-cola simply do not need to use much debt. their high rate of return enables them toe do most of their financing with retained earning.
9. interest rates
at certain point of time, when the general level of interest rates is low the use of debt financing might be more attractive when interest rates are high , the sale of stock may become more appealing.
10. control
the effect of debt versus stock on a management's control position can influence capital structure, if management currently has voting control, but is not in a position to buy any more new stock, it may choose debt for new financing . on the other hand , management may decide to use equity if the firms financial situation is so weak that the use of debt might subject it to serious risk of default because, if the firm goes in to default, the managers will almost surely lose their jobs. however, of too little debt is used management runs the risk of a takeover. thus, control considerations could lead to the use of either debt or equity.
11. flexibility
capital structure of a firm should be flexible i.e., it should be such as to be capable of being adjusted according to the needs of the changing conditions. it should be possible to raise additional funds whenever the need be, without much of difficulty and delay. a firm should arrange its capital structure in such a manner that it can substitute one form of financing by another.
12. nature and size of the firm
nature and size of a firm also influences its capital structure. a public utility concern has a different capital structure as compared to other manufacturing concerns. public utility concerns may employ more of debt because of stability and earning due to the nature of the business will have to rely mainly upon owned capital as it is very difficult for then to raise long term loans at a reasonable rate of interest, while a large company can arrange long term loans at reasonable terms and also can issue equity and preference share at case to the public.
13. legal requirements
the government has also issued certain guidelines for the issue of share and debentures. the legal restrictions are very significant as these lay down a framework with in which capital structure decision has to be made.
No comments:
Post a Comment