What are the determinant of capital structure of a company? OR ‘Determination of capital structure of a company is influenced by a number of factors’ explain six such factors.
Capital structure refers to the relative proportion of different sources of long term finance. Following factors are to be considered before determining capital structure.
a. Cash flow position: The cash available with the company should be enough to meet the fixed interest liabilities. Interest on debt is to paid irrespective of A company has to meet working capital requirements, invest in fixed assets and also pay the interest and principal amount of debt after a particular stipulated period. If cash position is sound, debt van be raised, and if not sound debt should be avoided.
b. Interest coverage ratio : it is the ratio that expresses the number of times the Net profit before interest and tax covers the interest Higher the ratio, better is the position of the firm to raise debt.
c. Control : Issue of Equity shares dilutes the control of the existing shareholders, whereas issue of debt does not as the debenture holders do not participate in the management decisions as they are not the owners of the fir. Thus if control is to be retained, equity should be avoided.
d. Stock market conditions : If the stock market is bullish, the investors are adventurous and are ready to invest in risky securities, equity can be issued even at a premium whereas in the Bearish phase, when the investors become cautious, debt should be issued as there is a demand for fixed cost
e. Regulatory framework : Before determining the capital structure of a company, the guidelines of SEBI and concerned regulatory authority is to be considered. For e.g companies Act, Banking regulation Act etc are to considered.
f. Tax rate : As interest on debt is treated as an expense, it is tax deductable. Dividend on equity is the distribution of profit so is not tax Thus if the tax rates are high, issue of debt is an attractive means as it is economical in nature.
