What is a Capital Structure and How It Affects your Business?
18

Dec 2020

Every business in the world needs funds to function, and as the company grows, the management needs to give more thought to the capital structure of the company. The primary objective of every business is to maximize the value of the firm, which will, in turn, increase the profitability of the shareholders. One of the best ways to increase the profitability of the business is to decide upon the capital structure of the business.

The capital structure is the basic foundation of the business and allows the management to make decisions that are important to the company. by changing the financial structure of the business, the company can affect the profitability of the business.

Let us know more about the Capital Structure of a Business

What is a Capital Structure?

A capital structure can be referred to as the number of funds in the control of a business that can be used to fund the day-to-day operations of the business. there are two ways to acquire capital for the business. These are Debt Capital or Equity Capital. A business can use either one of them or a combination of both of them to acquire capital in the long run.

A business can acquire Equity Finance by selling shares to the stockholders.

A business can acquire Debt Finance from many different sources, which will include bank Loans, Credit Card Debts, Personal Loans, etc. Debt finance needs to be paid back from where it was taken at a date decided by both parties. This also will comprise an interest for the total number of days the debt was taken.

What is the Meaning of an Optimal Capital Structure?

Business, at some point in time, needs to decide what will be the capital structure to be followed by the company. This capital structure used by a company should provide a complete benefit to a business.

In layman’s terms, the optimal structure of a business is the ideal mixture of equity and debt to fuel its capital. The Debt provides the lowest cost to capital in comparison to equity, but it also increases the risk of the company.

Thus the management of the business has to understand the all requirements of the company and accordingly arrive at an optimal capital structure that will employ both debt and equity.

How can Capital Structure Affect your Business?

The decision of a capital structure is a very big one as it will decide the future course of the company and how it conducts business. Here are some of the difference ways by which the capital structure of the business can affect a company:

1. It Affects Investor Confidence

An equity-based company will be more preferred by potential investors, not that it will have its own drawbacks. A company that has a large amount of debt capital needs to understand that it needs to return the money with interest. Thus the risk in debt capital is also high. This is why a business should plan ahead and decide the optimum capital structure of the business.

2. Alters The Risk Reward Ratio

With even a slight change in the capital structure, there is a change in the risk-reward ratio for the company as well as the investor. This is why an optimum capital structure will work towards decreasing the risk and, at the same time, increasing the reward for the investors.

3. It Can Affect the Time Frame in Which the Funds Are Collected

It takes a lot of time to acquire funds from equity, whereas though the time taken to acquire funds from debt may be low, the risk in such a case is high. Therefore, the management should decide if the business requires such funds at the earliest, or it can wait for some time.

4. Affect The Profitability of the Company

The decision of the capital structure has a major impact on the profitability of the company. Choosing between debt or equity or a mixture of both can be very important for the company as well as its investors.

This is why it is important to take professional assistance when it comes to making a decision about the Capital Structure of the Company.

If you are looking to have assistance on the matters of Capital Structure of your company, then you can take the assistance of JAXA Chartered Accountants. The experts at JAXA will figure out what is the ratio of debt and equity you should maintain for maximum efficiency and profitability.

To know about the various services provided by JAXA, Contact Us. We will be happy to assist you.

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What is a Capital Structure and How It Affects your Business?