The
Factor which play vital role in Capital Structure determination are divided
into two: -
(A)
Internal Factor: -
1.
Requirement of
Capital: - When a new business is started, it cannot issue variety of securities.
This is because there is considerable risk involved at initial stages of new
company. The ideal structure for new company is to raise capital through equity
shares.
2.
Size and nature
of business: -The size of the business has great impact on its capital structure. Large
manufacturing companies have huge investments in fixed assets such as land,
machinery, building etc. further this fixed assets can be offered as securities
against issue of debentures.
3.
Growth of
Business firm: -Different capital structure may be required at
various stages of development of company. At initial stages of development,
equity and short term loans are the main sources of finance. When a company
grows in size, it can utilize sources of finance such as preference shares,
debt capital, etc.
4.
Adequate and
stable earning: -The business
firms with stable earning will have 'stable earnings per share' (i.e. EPS) such
companies can utilize source of debt capital as they can easily pay a fixed
rate of interest. Therefore, developed companies usually employ (use) more
amount of loan capital. The business firm with unstable earning should not opt
debt in their capital structure, as they may face difficulty in meeting fixed
amount of interest.
5.
Cash position: -The companies expecting large and
stable cash inflow in future can utilize large amount of debt capital in their
capital structure. It quite risky for those companies whose cash inflow is
unstable and unpredictable to have debt capital.
6.
Period of finance: -While framing
capital structure the 'period for which finance is needed' should also be
considered. If funds are required on regular basis, the company should raise
funds through issue of equity shares.
7.
Attitude of
Management: -The capital structure is influenced by attitude of persons in the
management. The management's attitude towards 'control of firm'. Should be
noted minutely if the management has strong will of exclusive control, then
preference shares and debt capital are used as source of finance.
8.
Future plan and
development: -While designing capital structure, management should keep in mind
the future development and expansion plans. Equity capital can be issued in the
beginning. The debenture and preference shares may be issued in future to
finance development plans.
9.
Trading on equity: -The use of
borrowed capital for financing a firm is known as Trading on equity. The policy
of 'Trading on equity' is based on premise (principle) that, if the
rate of interest on debt is lower than rate of companies earning, the equity
shareholder will enjoy advantage in the form of additional profit. But if the
company earnings are not sufficient, it may face financial crisis. The interest
on debt has to be paid even in case of loss. The whole earnings may exhaust (waste) in payment of interest.
