Determination of ideal or optimal capital structure for any business company is not easy, reasoning that whereas on one side, the earning per share increased by increasing the volume of debt in total capital.
However, on another side, investment risk increases due to the high Debt component and as a result, the market value of share goes down.
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Characteristics of Ideal or Optimal Capital Structure
The following Features or Characteristics of Ideal or Optimal Capital Structure are worth consideration, along with the right of various types of securities on Income, claim on Assets and the right to exercise control:
1. Simplicity
The ideal or optimal capital structure should have a quality of simplicity.
Here, simplicity means initially raising funds should be through few types of securities, meaning thereby that only equity and preference shares should be issued and debentures be issued, Later on.
Thus, diversification insecurities should be introduced gradually, along with the development of the business. It will add to the confidence of the investors and raising funds will become easy.
In addition to it, along with keeping the capital structure simple, it should also be kept in view that it may not become much cheaper also, than the requirement.
Related: 18 Major Factors Affecting Capital Structure (Complete List).
2. Minimization of Risk
Various risks are attached to every business, like, Business competitions, changes in demand of the goods, natural climates, increase in taxes, increase in interest rates, reduction in purchasing power, increase in business cost, etc.
These risks have an effect on planning and building up of capital structure.
Hence, the capital structure should be such that these risks may be minimum and the burden thereof may be successfully Borne by the business if so required.
To minimize the risks, the component of high category securities in the capital structure is necessary.
3. Flexibility
Capital structure is not determined only for the immediate needs of the Enterprises, but also for long-term needs.
Hence, the capital structure should be such that the funds may be raised in the future also to meet the increasing needs of the business.
It should also be possible to reduce capital and funds when less capital is required.
4. Adequate Liquidity
The composition of capital structure and Assets of the institution should be such that the institution may always maintain adequate liquidity.
Hence, the company may issue such debentures, which may be repurchased in the market and maybe resold in the market, when needed.
In addition, these days system of issue of debentures having conditions of the repurchase is on increase for maintaining and adequate liquidity.
5. Full Utilization
While making capitalization, the institution should keep it in view that the procured money is fully utilized, meaning thereby that the volume of capital should be so determined that the institution may neither have overcapitalization nor undercapitalization.
Capitalization should be proper. When capitalization in the institution is proper, the capital sources of the institution do not remain idle and they are well utilized.
Related: 12 Importance of Decision Making in Business Management.
6. Maximum Profitability
The ideal capital structure for any business institution is that, with which the profitability of the business may maximum.
Although profitability depends upon the efficiency of the management of the business, it is also affected by the cost of the capital.
Hence, the capital structure should be so managed that the cost of capital is minimum so that capital becomes available according to the requirements and wastages are avoided.
7. Minimum Capital Cost
Capital may be obtained by various sources and costs are to be incurred for every source, like underwriting Commission, discounts, commission, advertisements, printing, interests or dividends, statements costs, expenses on transfer, etc.
The capital structure should be such that the capital of the cost of capital collection is minimum.
The costs of some sources are high and as low for some other sources.
Hence, the mix of various sources should be so selected that the average cost of the capital is minimum.
8. In Tune with Government Laws and Rules
Capital structure will be good and ideal when it is in consonance with government laws and rules.
The capital controller of India determines the guidelines for the issue of equity share capital, debt capital, preference share capital, etc.
Hence, the capital structure should be in accordance with these guidelines.
9. Attraction for Investors
The capital structure should have the quality to attract investors, otherwise, capital structure has no significance.
Hence, if the investors are invited to invest capital, then attention should also be paid on various aspects relating to the attraction.
The investors are generally attracted to those securities, which provide security of money, the regularity of income and higher opportunities for capital growth.
10. Cash Flow Efficiency
Attention should necessarily be paid on cash flow efficiency for a balanced capital structure of any business institution.
It should be so managed that the institution may be able to meet its expenses also after the meeting is fixed expenses.
Generally, the amount of loan, interest over it and other discount messages, etc. are included in fixed expenses.
So, if the cash flow of the institution is more stable, the loaning capacity of the Institution will also be high.
Related: 17 Importance of Leadership in Modern Business.
11. Maximum Return on Equity Capital
We know that equity shareholders are the real owners of a company and only they bear the real risk on investments.
So, the capital structure should be such that they may get the maximum returns (profits).
But, it is possible only when the institution is able to have certain and adequate income, regularly.
Although, accrual of this income must depend upon the efficiency of the managers.
But, even then, income may be raised By procuring Capital at low costs, by developing proper capital structure.
12. Maximum Control
Generally, the right of control over the institution is in the hands of equity shareholders.
But, this right may be transferred by giving voting rights to preference shareholders and debenture holders, in special circumstances.
Hence, the capital structure of the institution should be such that the management and control of the company may remain secured in the hands of equity shareholders.
However, if the percentage of shares held by them starts decreasing, then their control over the company may end.
Hence, while formulating the capital structure of an institution various Should be kept in view.
Thus, now you know the characteristics of an ideal or optimal capital structure.
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