Question

Write notes on Capital structure and its components. 

Answer 1

Meaning: -Capital structure constitutes two words i.e. capital and structure. Capital refers to investment of funds in the business while structure means arrangement of different components in proper proportion. Thus capital structure means' mix-up of various sources of funds in desired proportion'.

Definition: -" The long term sources of funds employed in a business enterprise." (R.H. Wessel)

Components / parts of Capital Structure

 There are four basic components of capital Structure. They are as follow:

1. Equity Share capital: -It is the basic of financing activities of business. Equity share capital is provided by equity shareholders. They buy equity shares and help a business firm to raise necessary funds. They bear ultimate risk associated with ownership. Equity shares carry dividend at fluctuating rate, depending upon profit.
2. Preference Share Capital: -Preference shares carry preferential right as to payment of dividend and have priority over equity shares for return of capital when the company is liquidated. These shares carry dividend at a fixed rate. They have limited voting rights.
3. Retained earnings: -it is an internal source financing. It is nothing but ploughing back of profit.
4. Borrowed Capital: -

(a)       Debentures: -A debenture is an acknowledgement of loan raised by company. Company has to pay interest at an agreed rate.

(b)       Term loan: -Term loans are provided by bank and other financial institutions. They carry fixed rate of interest. 

To understand above concept thoroughly, we shall consider following balance sheet

 

Liabilities	Amount	Assets	Amount
Share Capital 5000 Equity Shares of Rs 10 each fully paid 1000, 10% Preference Shares of 100 each   Reserves & Surplus General Reserves & Surplus   Liabilities 1000, 12% Debentures of Rs. 100 each fully paid   Sundry Creditors Bank Overdraft Bills Payable	50,000   1,00,000         20,000       1,00,000       40,000 20,000 10,000	Fixed Assets Building Plant & Machinery   Current Assets Cash in hand Cash at bank sundry Debtors Inventories (stock)	2,00,000 80,000       14,000   24,000 12,000 10,000
	3,40,000		3,40,000