Factors to take into consideration while deciding the capital structure of your company.

What factors would you take into consideration while deciding the capital structure of your company or any other company of your choice?

The permanent long-term financing of a company, including long-term debt, common stock and preferred stock, and retained earnings. It differs from financial structure, which includes short-term debt and accounts payable. The various factors affecting the capital structure decision are:

1. Leverage or trading on equity
2. Capacity of Raising Funds
3. Management attitudes
4. Control
5. Assets structure
6. Cash Flow ability of a company
7. External environment such as the state of capital market, taxation policy, state regulations etc.
8. 'Other factors such as, the size of the business, age of the 'company credit standing, period of finance, lender attitude etc.

1. Leverage or trading on equity: The degree to which an investor or business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may also be unable to find new lenders in the future. Financial leverage is not always bad, however; it can increase the shareholders' return on their investment and often there are tax advantages associated with borrowing. also called leverage. Some of the main conclusions regarding the leverage in the capital structure such as use of fixed cost or fixed return sources of finances may be reemphasized. Debts and pre share capital results' into magnifying the earnings per share (EPS) prevailed the firm earns more on the assets purchased with these funds than the cost of their use. Earnings before interest and taxes (EBIT) and EPS relationship are the means to examine the effect of leverage. Out of per share capital and debt,' the leverage impact is felt more in the case of debt because their source of finance costs lower, than per share capital and also the interest payable on, debt is, tax deductible. The use of fixed cost sources of finances also adds to the financial risk of the company and, therefore, it should not be used beyond a point where the amount of fixed commitment charges equals the level of EBIT. To give, up because of its effect on EPS financial leverage is one the important consideration in planning the capital structure for the company.

2. Capacity of Raising Funds: The size of a company may influence its capital and availability of funds from different sources. A small company finds great difficulties in raising long-term loans. If it is able to obtain some long-term loan, it will be available at a higher rate of interest and inconvenient terms. The highly restrictive covenants in loan agreements incase of small companies make their capital structures very inflexible and management cannot run business freely without any interference. Small therefore, depend on share capital and retained earnings for their long-term funds. It is quite difficult for small companies to raise share capital in the capital markets. Also, the capital base of most small companies is so small that they are not allowed to be registered in the stock exchanges.

3. Management Attitudes: Management's attitude concerning control of enterprise and risk, involved determine the debt or equity in the capital structure and any analysis of capital structure planning can hardly afford to ignore this factor. In fact every addition of equity unit in the capital structure presents management to participate in the company affairs to that extent. Therefore, while planning capital structure, firms may prefer debt to be assumed of continued control. .

4. Control: In redesigning the capital structure, sometimes the existing management is governed by the desire to continue control over the company. This is particularly so in the case of the firms promoted by entrepreneurs. The existing management team not only wants control and ownership but also be manage the company, without any outside interference.

5. Assets Structure: Composition and liquidity of assets may also influence the capital structure decision of the firm. Firms with long lived fixed assets, especially when demand for their output is relatively assured utilities for example - use long-term debt extensively similarly greater the liquidity the more debt that generally can be used all other factors remaining constant. The less liquid the assets of firm the less flexible the firm can be in meeting its fixed charged obligations.

5. Cash flow ability of the company: When considering the appropriate capital structure it is extremely important to analyze the cash flow ability of the firm to serve fixed commitment charges. The fixed commitment charges include payment of interest on debentures and other debts, preference dividend and principal amount. Thus the fixed charged depend upon both the amount of senior securities and the terms of payment. The amount of fixed charges will be high if the company employs a large amount of debt or preference capital with short-term maturity. It is therefore, prudent that for servicing fixed charges at proper time, the management must ensure the availability .of cash because inability on the part of management may result in financial insolvency. Therefore, cash flow analysis is essential to consider while planning appropriate capital structure. Obviously, the greater and more stable the expected future cash flows of the firm, the greater the debt capacity and vice-versa. To be on a safe side the cash flow ability must be determined in the period of depression very carefully.

6. External Environment: Any decision relating to the pattern of capital structure must be made keeping in view the external factors such as state of capital market, taxation policy, state regulations etc. If the capital market is likely to be planned in bearish state and interest rates are expected to decline the management should postponed the debt for the present in order to take advantage of' cheap debt at a larger stage. However, if debt will become costlier and will be on scarce supply owing to bullish trends of the capital market, the management may inject additional doses of debt in capital structure.

7. Other Factors: All the factors specified above are of crucial importance in matters of capital decision. Other factors such as the size of the company, age of the company credit standing of the company, period of finance, tender's attitude, capital structure decisions of competitors etc. are equally important. Smaller companies confront tremendous problem in raising fund and these companies have to pay higher interest on debt and have to agree to inconvenient terms of loan. These companies as a result are compelled to depend heavily on retained earnings and share capital. Similarly age of company plays an important role. New companies face a lot of uncertainty in the initial periods of operation, as they are completely unknown to the suppliers of funds. These companies are compelled to depend upon their own, sources of funds. Small firms or newly started funds have low standing in the market and they are compelled to pay a higher rate of interest on long-term debts. Similarly the period of finance should be paid due attention in the capital structure decision. When funds are required for permanent investment in a company, equity share to capital is preferred. When funds are required to finance modernization programs such as overhauling of machines and equipment and aggressive advertising campaign, the company can issue preference share and or debentures. Regardless of management analysis of proper leverage factor for their companies, there is no question but that lender's attitudes are frequently important and sometimes the most important determinant of capital structure. Before adopting a capital structure the management may discuss their with its prospective lenders if possible.1t is also prudent to know about the existing practices regarding the capital structure is radically different from its competitors, there is every need to give careful thought to this duration. Such a departure is unhealthy in the absence of compelling circumstances.