In order to run and manage a company, funds are needed. Right from the promotional stage upto – end, finances play an important role in a company’s life. If funds are inadequate, the business suffers and if funds are not properly managed, the entire organisation suffers.
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It is therefore, necessary that correct estimate of the current and future need of capital be made to have an optimum capital structure which shall help the organisation to run its work smoothly and without any stress.
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“Capital structure of a company refers to the composition or make up of its capitalisation and it includes all long-term capital resources viz., loans, reserves, shares and bonds.” The capital structure is made up of debt and equity securities and refers to permanent financial of a firm.
It s composed of long term debt, preference share capital and shareholders funds. For raising long-term finances, a company can issue three type of securities viz., equity shares, preference shares and debentures. A decision about the proportions among these types of securities refers to the capital structure of an enterprise.
Financing the firm’s assets is a very crucial problem in every business and as a general rule; there should be a proper mix of debt and equity capital in financing the firm’s assets. The use of long-term fixed interest bearing debt and preference share capital along with equity shares is called financial leverage or trading on equity.
Thus, optional capital structure is that combination of debt and equity that leads to the maximum value of the firm and hence the wealth of its owners and minimises the company’s cost of capital.