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Capital Structure Defined
Capital is all that amount of money or wealth available to a person or entity. The funds that the company owns can be divided into those that are contributed by the owners/shareholders and those that are obtained from the loans to third parties.
A Little More on Capital Structure
In finance, businesses can decide the capital structure as “the way a company finances its assets through a combination of capital, debt or hybrids.” It is then the composition or “structure” of their liabilities and their net worth.
For example, a company that is financed with 20 million common shares and 80 million loans and bonds, says that 20% is financed with shares and 80% is financed with debt.
Actually, the capital structure can be very complex and include dozens of sources each at a different costs.
To calculate the capital structure of a company, compare the value of equity of outstanding equity to the value of debts.
There are four fundamental factors that influence capital structure decisions:
- The financial risk of the capital of the company. If the entity increases its financing through debt, the required yield of the share capital will increase, as the financing through debt increases the risk that the shareholders run.
- The fiscal position of the company. For a financially healthy company, debt is generally advantageous over equity, as interest is deductible. For a cash-strapped company, debt is burdensome, as it requires immediate payments. Equity is cheap when no distributions are made.
- Financial flexibility or the ability to obtain capital on reasonable terms.
- Conservative or aggressive funding attitudes of the board.
References for Capital Structure