Components of Capital Structure – Scholarszilla
Table of Contents
Components of Capital Structure
Capital structure means ‘mix up of various sources of funds in desired proportion’. To decide capital structure means, to decide upon the ratio of different types of capital.
Definition of Capital Structure
R. H. Wessel: “ The long term sources of funds employed in a business enterprise”.
John Hampton: “A firm’s capital structure is the relation between the debt and equity securities that make up the firm’s financing of its assets”.
Thus capital structure is composed of owned funds and borrowed funds. Owned funds include share capital, free reserves and surplus, whereas, borrowed funds represent debentures, Bank loans, and long-term loans provided by financial institutions.
Components of Capital Structure
There are four basic components of capital structure. They are as follows :
(1) Equity share capital
It is the basic source of financing activities of business. Equity shares are shares that get dividend and repayment of capital after it is paid to preference shares. They own the company. They bear ultimate risk associated with ownership. They carry dividend at fluctuating rate depending upon the profits.
(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 fixed rate.
(3) Retained earnings
It is an internal source of financing. It is nothing but ploughing back of profit.
(4) Borrowed capital
It comprises the following :
a) Debenture :
It is an acknowledgment of loans 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 a fixed rate of interest.
To understand the above concept, we shall consider the following Balance sheet and calculate the values
| Liabilities | Amount | Assets | Amount |
| Share Capital | Fixed Assets | ||
| 10,000 equity shares of Rs 10 each fully paid | 1,00,000 | Building Plant and Machinery | 4,00,000 2,00,000 |
| 5,000 preference shares of Rs 100 each fully paid. | 5,00,000 | Current Assets | |
| Reserves and Surplus | 50,000 | Sundry Debtors | 1,00,000 |
| Liabilities | Inventories | 50,000 | |
| 1000, 10% Debentures of Rs 100 each fully paid | 1,00,000 | Cash in hand Cash at bank | 10,000 40,000 |
| Sundry creditors | 30,000 | ||
| Bills payable | 20,000 | ||
| 8,00,000 | 8,00,000 |
Capital Structure = Equity Share Capital + Pref. Share Capital + Reserves + Debentures
= 1,00,000 + 5,00,000 + 50,000 + 1,00,000
= 7,50,000
