Chapter – 9 Financial Management (5+5 = 10 Marks) 60-80 words

State 5 factors that determine/affect the CAPITAL STRUCTURE of a company? (very important)

Financial leverage:

The financial manager should carefully examine how the use of the proposed financing mix will affect the risk and returns of the owners.

The financial leverage used by the company will depend on the amount of risk the company would like to take.

Flexibility:

The capital structure of the company should be flexible enough to -

Adapt to changing conditions whenever required.

• Raise additional funds without undue delay and cost.

Legal framework:

• The Companies Act and SEBI provide guidelines from time to time on how the shares and debentures should be issued to the public.
• The finance manager of the company must be aware of all these rules and regulations and carefully consider these guidelines while deciding on the capital structure of the company.

Market conditions:

The conditions in the capital market also influence to a certain extent the decisions regarding capital structure. It may not affect the capital structure initially but when the company requires additional funds then the appropriate time for issuing the shares or debentures should be considered.

Control:

• If the owners want to maintain a tight control over the company it should obtain its funds through loans because debenture and preference shareholders do not have a right to manage the affairs of the company.
• However if the owners want to dilute the control, they can raise funds through issue of equity shares, as equity share holders have a right to vote.

One of the EFFECTS OF UNDER CAPITALIZATION is that the market value of shares goes up. But still under capitalization is not considered good for the Co. Why?

Effects of under capitalization on the company: (increases, goodwill, credit worthiness competition and demand for higher salaries)

• Increases creditworthiness and goodwill of the company as market value of shares goes up due to high profitability
• An under capitalized company earns more than the prevailing rate of profit in the industry. But this may induce competitors to enter the same line of business and pose a threat to the company.
• The employees demand higher salaries, which may lead to dissatisfaction and labour tension.
• Secret reserves are built.
• Exceptionally high rate of profit may induce Government to impose heavy tax, which leads to reduction in company profits.