Capital Structure:Meaning

Capital is the basic requirement of every business firm. All firms have to do some arrangement for its Capital. They need capital for the smooth operation of their business activity. Different amount of capital needed at different level of a business activity. They need capital for short term and long term period. Short term capital need for day to day working of the business activity.

Working capital is need for short term which is arranged through current assets to pay the current liabilities. Long term sources of financing is contributed through equity shareholder, preference share holder, debenture holder, bond holder, loan from bank, retained earnings and earning profits. They use this capital to makes profits or get losses. So they have to compensate these financiers for their sacrifice in the forms of interest and dividend. So they have rationally needed to take decision in the formation of capital structure

The significance of capital structure decision among corporate have increased. Although the proportion of debt financing is similar, each sector adopted different financing patterns. Every firm has to maintain optimum capital structure so that overall cost of capital is minimized and hence return on capital maximized.

After determination of quantity of capital, the finance manager’s next step is to determine the capital structure. If a proportion leads to minimize the cost of capital and increases the rate of return, then it will be said that optimum capital structure achieved. So capital structure is a decision of management to decide the best proportion of equity and debt that leads higher rate of return over cost of capital.

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