(^296) Financial Management
- Solvency: Company should not run the risk of insolvency because of the increased
debt in the balance sheet. - Flexibility: The capital structure should provide enough flexibility to the company
to raise additional funds whenever required without constraints. - Control: Control of the company should not be lost because of the high dilution of
equity.
This means that the finance manager has to make a compromise between the best
capital structure and the peculiar needs of the company.
Factors Influencing Capital Structure
In the real world taking decisions on capital structure is not so easy as it is made out till
now. In deciding the capital structure of a company, the following points need to be
considered:Corporate Strategy
Corporate strategy is the main factor determining the financial structure of a company.
The market growth rates form a basis for defining the Organisation structure, Investment
in Assets and Overall Capital Intensity (Debt/Equity Financing). The fact that the
company has to source funds from the markets, makes it imperative to factor in the
market responsiveness to the company's call for funds. Capability to service the funds,
both debt and equity and the growth phase of the business have to be considered in
tandem. Other strategic decisions like management control level, risk averseness or
risk taking nature of the management, etc. have also to be considered.
Ultimately, the most appropriate capital structure will be the one, which most closely
supports the strategic direction of the business with the least cost and at a reasonably
acceptable risk level.Nature of the Industry
The nature of the industry plays an important role in capital structure decisions.
Capital Intensity: Capital structure should factor in the type of the assets being financed.
Capital intensive firms rely mostly on long term debt and equity. Generally speaking,
long term assets should be financed by a balance between term debt and equity and
short term assets should be financed less by long term sources (like term debt and
equity) and more by short term debt. The terms current (short term) and fixed (long
term) assets are determined by the nature of the industry and the business itself. For
example, a rapidly growing non-seasonal and non-cyclical business may regard part of
its investments in short term assets like inventories and accounts receivable, as permanent