Capital Structure Meaning – Principles of Capital Structure
Capital Structure Meaning
A company can raise its capital from different sources, such as owned capital, borrowed capital, or both. Owned capital consists of equity share capital, preference share capital, reserves, and surplus. On the other hand, borrowed sources include debentures, loans, etc.
A combination of different sources is used in capital structure. It is nothing but a ‘security mix.’
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.
Principles of Capital Structure
Two basic principles are observed while making decisions about capital structure.
(1) The ratio of ‘debt to equity’ should always be geared to the degree of earning stability.
(2) The capital structure must be balanced with an adequate ‘equity cushion’ to absorb the shocks of the business cycle and to afford flexibility.
