OMTEX CLASSES: Internal Factors influencing Capital Structure?

Internal Factors influencing Capital Structure?


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.