An appropriate capital structure
Flexibility
The financial requirements of the company change with circumstances. Hence it is necessary that capital structure is flexible so that it may be adapted to changing conditions. For instance, it should be possible in times of depression when a company needs less finance to repay the debentures and redeemable preference shares. Also, there should be enough unclassified capital in the authorized capital of the company so that any expansion scheme may be easily financed. This is the reason why most of the companies fix quite a large amount of authorized capital and issue shares as and when required. For example, the authorized capital of the Indian Rayon Corporation Limited was Rs.10 crores, while its paid up capital was Rs.2 crpres. The capital structure should not be so rigid and inflexible as to become a burden on the management of the company.
Provision against contingencies
It should be possible to raise enough funds to meet unforeseen needs. For this purpose, generally, ordinary shares are issued first and provision is made for raising enough funds through debts in times of crisis. Keeping in view the long term financial needs of the company, the authorized capital should also be quite large.
Economy
The capital structure should be such tat it imposes less burden on the company and yet it allows enough scope for raising sufficient funds at an appropriate time. The burden of interest payment on debentures and that of dividend payments on cumulative preference shares is almost inescapable. Hence in a business in which revenues are unstable and fluctuating, a high level of ordinary shares is most economical. But in a business in which income is stable and regular (e.g. public utilities), a large part of capital may be obtained through the issue of debentures. Thereby, enough capital can be raised and it can be repaid when financial requirements are low. If capital is less than required, the growth of the company is impeded and if capital is more than required, its profitability is reduced.
Consistent with the company’s objectives
The capital structure should be in conformity with the basic objectives of the company. For example, the amount of fixed capital should be quite less than that of short term capital in the capital structure of a company which is set up for the purpose of trading only. An industrial enterprise, on the other hand, needs more capital in the form of fixed assets.
Profitability
Profitability depends on the efficiency with which capital is used. If, according to the nature of business, a proper ratio is maintained between owned capital and borrowed capital, it can be efficiently utilized. Similarly, there should be a proper balance between fixed capital and working capital.
Solvency
Capital structure should not impair the solvency of the company. The amount of debts should be so fixed that interest can be paid easily and at right time. The inflow of cash should be taken into account while fixing the proper amount of debts.
Though all the above factors are essential for building an appropriate capital structure, Yet, in practice, they all can be hardly combined. Hence the management of each company should try to evolve a capital structure that suits them best in view of the nature of their business, its size and duration, credit and goodwill in the market the stages of business cycle etc.
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