Let us make an indepth study of the meaning, concept, importance and factors of capital structure. But neither of these two theories provide a complete description why some firms prefer debt and others prefer equity finance under different. Share repurchases have proven a flexible and effective means of returning capital to investors. Capital structure is the allocation of debt and equity that a firm uses to fund its operations and expansions. Capital structure is the mix between owners funds and borrowed funds. Capital structure financial definition of capital structure. Capital structure how a company finances its operations. Capital structure theory financial definition of capital. So capital structure means the arrangement of capital from different sources so that the longterm funds needed for the business are raised. The capital employed consists of both the owners capital and the debt capital provided by the lenders.
The capital structure is how a firm finances its overall operations and growth by using different sources of funds. This is the maximum amount of credit that can be extended by lenders. This is a type of intellectual capital that includes any structures that help employees to be more productive and creative. Since capital structure is the amount of debt or equity or both employed by a firm to fund its operations and finance its assets, capital structure is typically expressed as a. A read is counted each time someone views a publication summary such as the title, abstract, and list of authors, clicks on a figure, or views or downloads the fulltext. Capital structure is an integral underlying model for capital creation. Capital structure management a companys capital structure refers to the combination of its various sources of funding. During the depression period, the companys capital structure generally consists of debentures and loans. The term structure means the arrangement of the various parts. It allows a firm to understand what kind of funding the company uses to finance its overall activities and growth. Definition of complex capital structure the use of different forms of securities, rather than relying solely on one class of common stock.
The survey would then proceed to document the answers available in the litera ture. Capital structure commission authorizes the percentage of common equity, preferred stock and debt that utilities are estimated to hold based on a reasonable capital structure. This means that managers will use the excess free cash flow available to fulfil his personal interests instead of increasing returns to the shareholders. The capital structure of a company is made up of debt and equity securities that comprise a firms financing of its assets. Unfortunately, there has been little consensus among researchers on what the optimal capital structure is.
Capital structure is also referred as financial structure of a firm. Capital structure is referred to as the ratio of different kinds of securities raised by a firm as longterm finance. Capital structure in financial term means the way a firm finances their assets through the combination of equity, debt, or hybrid securities saad, 2010. It is the permanent financing of a firm represented by longterm debt, preferred stock and net worth. So it relates to the arrangement of capital and excludes shortterm borrowings. However, it is important to synthesise the literature on capital structure and where possible, to relate the literature to known empirical evidence.
Capital market conditionin the lifetime of the company, the market price of the shares has got an important influence. A business organization utilizes the funds for meeting the everyday expenses. Capital structure is the mix of financial securities used to finance the firm. From a technical perspective, the capital structure is the careful balance between equity and debt that a business uses to finance its assets, daytoday operations, and future growth. The term capital structure refers to the relationship between the various longterm forms of financing such as debenture, preference share capital and equity share capital. It is made up of debt and equity securities and refers to permanent financing of a firm. Capital structure wharton finance university of pennsylvania. The optimal capital structure of a firm is often defined as the proportion of debt and equity that results in the lowest weighted average cost of capital wacc. The capital structure is the particular combination of debt and equity used by a company to finance its overall operations and growth.
Capital structure is the mix of ownersupplied capital equity, reserves, surplus and borrowed capital bonds, loans that a firm uses to finance business. Generally, a firm can go for different levelsmixes of debts, equity, or. Capital structure the makeup of the liabilities and stockholders equity side of the balance sheet, especially the ratio of debt to equity and the mixture of short and long maturities. Capital is accumulated labor in its materialized form or its incorporated, embodied form which, when appropriated on a private, i. Capital structure means the structure or constitution or breakup of the capital employed by a firm. Capital structure refers to an arrangement of the different components of business funds, i. Capital structure definition is the makeup of the capitalization of a business in terms of the amounts and kinds of equity and debt securities. A firms capital structure is the composition or structure of its liabilities. B net operating income noi approach contrary to the ni approach the noi approach suggests that the capital structure decision of a firm is an irrelevant factor to the valuation of a firm i. Capital structure that maximizes the value of company or stock prices is the best capital structure husnan and pudjiastuti, 1994. The capital structure of a firm is very important since it related to the ability of the firm to meet the needs of its stakeholders. You can figure out the capital situation of a business by knowing how much debt it has.
According to this definition, the capital structure of a firm can be ascertained by knowing how much of. The cost depends on the health of the companys balance sheeta triple aaa rated firm can borrow at extremely low rates vs. Equity capital is the funds that the firms owners are trusting with the company and the retained earnings that represent profits from previous years, which are not distributed. Pdf despite a vast literature on the capital structure of the firm there still is a big gap between theory and practice. Modigliani and miller 1958 were the first ones to landmark the topic of capital structure and they argued that capital structure was. Chapter iii concepts and theories of capital structure and profitability. A company with a complex capital structure might have a. Organizational capital are elements of organizational culture that are independent of employees. The textile industry starting from yarn manufacturing industry spinning, cloth. Capital structure refers to the different options used by a firm in financing its assets bhaduri, 2002. It is the employment of an asset source of finance for which.
Debt comes in the form of bond issues or longterm notes. Capital structure is sometimes referred to as a companys debt to equity ratio. Most companies are funded by a mix of debt and equity, including some shortterm debt, some longterm debt, a number of shares of common stock, and perhaps shares of preferred stock. This structure seeks to lower the cost of capital so that a firm is less dependent on creditors and more able to finance its core operations through equity. The capital structure involves two decisionstype of securities to be issued are equity shares, preference shares. The three most basic ways to finance are through debt, equity or the issue of stock, and, for a small business. Capital structure, as its name itself signifies, is the composition of the capital employed by the firm from various sources of finance. Capital structure a reading prepared by pamela peterson drake outline 1. The debt capital in a companys capital structure refers to borrowed money that is at work in the business. In other words, it shows the proportions of senior debt, subordinated debt and equity common or. Capital structure definition and meaning collins english. The capital structure of a firm is some mix of debt, internally. Irrelevance theorem a benchmark striking result is that under fairly general conditions, the value of the firm defined as the sum of value of debt and. The value of a firm is defined to be the sum of the value of the firms debt and the firms equity.
The capital structure of the firm represents its investment and financing strategy. Capital structure of a firm is a reflection of the overall investment and financing strategy of the firm. Next issues relevant to capital structure and costs of different types of capital or component costs of capital are discussed. Financing the firms assets is a very crucial problem in every business and as a general rule there should be a proper mix of debt and equity capital in financing. Learn how mergers and acquisitions and deals are completed. In general, capital structure is the amount of equity and the amount of debt on hand at a given company. While in period of boons and inflation, the companys capital should consist of share capital generally equity shares.
The capital structure of a business is the mix of types of debt and equity the company has on its balance sheet. Capital structure is the particular combination of debt and equity used by a company to funds its ongoing operations and continue to grow. According to this approach the wacc and total value of a firm are independent and are. Capital structure definition of capital structure by.
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