The composition of the financial structure represents the whole equity and liabilities side of the Balance Sheet, i. Debt refers to loans and other types of credit that must be repaid in the future, usually with interest. Cash Flow ability of a company 7.
Private placement is simpler and more common for young companies or startup firms. Importance of Capital Structure Planning Importance of Capital Structure Planning For the real growth of the company the financial manager of the company should plan an optimum capital structure for the company.
Effective managers make capital budgeting decisions while using data-driven analyses. A mix of equity, preference and debt capital in different proportions.
In general, companies that tend to have stable sales levels, assets that make good collateral for loans, and a high growth rate can use debt more heavily than other companies.
What is the impact of this tax shelter on the value of the firm? Growth of the Country: Needless to say that it is desirable to minimise the cost of capital. This idea, called the time value of money, is pivotal in the net present value method of capital budgeting.
Before adopting a capital structure the management may discuss their with its prospective lenders if possible. Therefore, capital structure decisions provide firms with an effective tool of minimizing their overall cost of capital.
Among those eligible for this kind of assistance are small businesses, certain minorities, and firms willing to build plants in areas with high unemployment. The factors to be considered whenever a capital structure decision is taken are: In general, the discussion on the issue of optimum capital structure is highly theoretical.
Conservation does not mean employing no debt or a small amount of debt. The judgement of the person or group of persons making the capital structure decision plays a crucial role.
After establishing its creditworthiness in the market, its capital structure gradually becomes complex.
So the financial structure should be such that when the business environment changes structure should also be adjusted to cope up with the expected or unexpected changes. The main requirements for private placement of stock are that the company cannot advertise the offering and must make the transaction directly with the purchaser.
Because of its effect on the earnings per share, financial leverage is one of the important considerations in planning the capital structure of a company. The company should also be in a position to redeem its preference capital or debt whenever warranted by future conditions. Similarly age of company plays an important role.
Finally, the lender will try to ascertain whether the small business can provide a reasonable amount of collateral to secure the loan.
Barron's Educational Series, Conversely, the entire equity and liabilities side shows the financial structure of the company. Capital structure is concerned with the quantitative aspect. To be on a safe side the cash flow ability must be determined in the period of depression very carefully.
A cash flow's present value is the value that a cash flow would have today, in contrast with some time in the future.
In addition, many companies compare this value to a required rate of return. The companies with high level of the Earnings Before Interest and Taxes EBIT can make profitable use of the high degree of leverage to increase return on the shareholders' equity. On the other hand, very scanty research has been carried out to establish the determinant of capital structure in emerging and in the less developed countries.
At one time, the market favours debenture issues and at another time, it may readily accept ordinary share issues. Types of debt financing available to small businesses included private placement of bonds, convertible debentures, industrial development bonds, leveraged buyouts, and, by far the most common type of debt financing, a regular loan.
These factors are highly psychological, complex and qualitative and do not always follow the accepted theory. Therefore, cash flow analysis is essential to consider while planning appropriate capital structure.
When evaluating a small business for a loan, lenders like to see a two-year operating history, a stable management group, a desirable niche in the industry, a growth in market share, a strong cash flow, and an ability to obtain short-term financing from other sources as a supplement to the loan.
One of the features of a sound capital structure is conservation.Importance of Judicial Efficiency in Capital Structure Decisions of Small Firms Given that resource endowments and demand for judicial services vary across.
Shift the capital structure towards more debt investment opportunity set and reserve borrowing capacity Firms with many investment opportunities should maintain reserve borrowing capacity so that debt can be used if an especially good investment opportunity comes along.
That said, a high leverage ratio and/or an aggressive capital structure can also lead to higher growth rates, whereas a conservative capital structure can lead to lower growth rates.
It is the goal of company management to find the optimal mix of debt and equity, also referred to as the optimal capital structure. For this reason, capital structure affects the value of a company, and therefore much analysis goes into determining what a company's optimal capital structure is.
The Modigliani and Miller propositions (created by financial theorists Franco Modigliani and Merton Miller) address this question. A comprehensive guide to making better capital structure and corporate financing decisions in today's dynamic business environment Given the dramatic changes that have recently occurred in the economy, the topic of capital structure and corporate financing decisions is critically important.
Despite the importance of capital investment to small firms, most capital budgeting sur- veys over the past 40 years have focused on the investment decisions of large firms (examples include Moore and Reichardt,Scott and Petty,and Bierman, ).Download