Components of Capital Structure
A capital structure is the careful balance among debt and equity. A company uses this to finance its resources or assets and daily basic operations. In corporate finance, capital structure is the way a company finances its resources by combination of debt, equity and hybrid securities. Components of capital structures are divided into two main categories. Following are the both categories and their respective components:
- Shareholder’s Funds
- Borrowed Funds
Shareholder’s funds are those funds that are provided by the owners. These are also known as ownership capital or owned capital. Following are the components of this category are:
1. Equity Capital:
This component of the capital structure permanent capital and cannot be withdrawn through the lifetime of the business. It is the real risk bearers. However, those who have such component also enjoy rewards. The liability of this component is restricted to the capital contributed. Equity capital is also name as risk capital or own capital.
2. Preference capital:
Preference shareholders are the owners of the firm as well. They acquire preference concerning repayment of capital and payment of dividends. Different preference shares are as follows:
- Convertible and Nonconvertible
- Cumulative and Noncumulative
- Redeemable and Nonredeemable
3. Retained Earnings:
In retained earnings, all the profit is not being distributed to the shareholders. But the firm retains a part of profit for self financing. It consists of the sum total of the profit which is realized over the years and has also been reinvested. That is why it is also call plough back of profit or self financing.
It is the amount that is raise by way of credit or loans. Following are the main components of borrowed capital:
It is the part of borrowed capital in which the creditors are the dentures holders. For the convenience of investors different types of debentures have been issue.
2. Term Loan:
In this type of capital structure’s component, organizations attain medium term and long term loans from financial institutions. The banks advance loans to the firms in US dollars and it can be repayable by several numbers of installments. Organizations have to order the collateral security for obtaining term loans.
3. Public Deposits:
It is the deposit from the public such as the employees, shareholders of the company, customers etc. The money will be receive by a firm other than banks is known as public deposit. Most of the companies prefer this type of method because these deposits are unsecure. Usually a company accepts this type of deposits for about 3 years or more than that.
Capital structure is an overview of all the claims that many of the clients have on the business. Furthermore, the debt owners can take all these claims as a lump sum of cash owed to the principal or manager.
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