Appropriate Capital Structure

Appropriate Capital Structure

Appropriate Capital Structure

Capital structure is the proportion of different sources of long term fund like common stock, preferred stock, and debt capital. Appropriate Capital Structure is that capital structure at that level of debt-equity proportion where the market value per share is maximum and the cost of capital is minimum.

In another way, capital structure is the permanent financing of a firm represented by long term debt, preferred stock, common stock but excluding all short term credit. It is important for a company to have an appropriate capital structure. It refers to the most optimum way of finding a combination of debt and equity.

Features of an Appropriate Capital Structure –

Return – should generate maximum returns to the shareholders without adding cost to them.

Profitability Aspect: the cost of capital is minimum and market price per share is maximum.

Risk – to the point debt does not add significant risk it should be used otherwise its use should be avoided.

Liquidity Aspect: The Capital structure should be composed in a way that the firm has enough assets to cover its liabilities.

Flexibility- It should also be possible for the company to provide funds whenever needed to finance its profitable activities.

Capacity – The debt capacity of a company depends on its ability to generate future cash flows.

Control – The owner’s of closely-held companies are particularly concerned about dilution of control.