Determinants of Capital Structure: An Empirical Study

The assignment explores the concept of capital structure and its significance for organisations. It discusses how capital structure decisions impact firm performance and profitability. The study focuses on the manufacturing sector in Pakistan and examines the relationship between capital structure and firm performance. It also reviews relevant literature and provides an empirical analysis of the topic.

FINANCIAL
MANAGEMENT

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK .............................................................................................................................................1
LITERATURE REVIEW ...........................................................................................................1
CONCLUSION ...............................................................................................................................6
REFRENCES ..................................................................................................................................7
.........................................................................................................................................................7

INTRODUCTION
Financial management described as the management and controlling of money in order to
achieve organisational goals and objectives (Albul, Jaffee and Tchistyi, 2015). It can be
considered as the important function of organisation which is directly associated by the top level
management department. Financial management refers to the budgeting area which involves
planning for atypical and typical expenses that are essential for organisational activities and
performance. It is very important term because it help in effective financial decision. Capital is
an essential element for every business organisation because it helps in running business
activities in an effective manner so that company can easily get more profit and revenue and
increase their financial position. Capital structure considered as how an organisation provide
capital and finances for conducting over all operations and growth with the help of using various
sources of funds. This report is based on the financial management and capital structure.
TASK
LITERATURE REVIEW
Topic: Optimal Capital Structure.
Capital structure is most essential term in every business organisation, firms are very
much concern about establishing an effective capital structure in order to manage finance in firm.
This structure is exist in firm for managing captive in firm in order to finance all operations and
activities of company which are increasing growth and profit. An organisation take funds form
various resources in respect of effective completion of work and task. Capital structure is based
on the two major aspects such as debt and equity, in which debt considered in the form of bond
issues and long term notes payable, thus equity can be described as the common stock, preferred
stock and retained earnings. The requirement of working capital is also considered as the
essential part of capital structure. Every firm is focused on preparing an effective balance sheet
with proper and accurate detail related with firms capital. It helps an organisation to investing in
firms stock. Balance sheet can be ascertained as the strength of company which is categorised in
to three major parts such as working capital adequacy, capital structure ans asset performance.
The capitalisation of company explains its compositions which are related with permanent and
long term capital, that considered as a combination of debt and equity (Boot and Thakor, 2011).
Debt and equity considered as the key indicators of firms balance sheet, it is required for firm to
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use debt and equity for some proportional use which create value for firm. Each organisation
focuses on establishing a healthy capital structure which consist a high level of equity and
correspondingly low level of debt, because equity can be considered as a very positive reflection
of financial growth and fitness. Corporate officers, professional investors are helpful in providing
a brief discussion on companies capital structures (Hackbarth and Mauer, 2011). This consist as
the percentage of money and capital which are used at work place as per the different type of
firm. The capital is categorised into two forms such as debt capital and equity capital. The
requirement of capital is depend on the size and type of business, small business organisation
need very less amount of capital to conduct operational activities in an effective manner in order
to earn more profit and growth. These type of firms are not concern about creating companies
image in mind of customers. Large and big enterprises need high range to capital to implement
operational activities, in order to increasing growth and success for company and they are more
focuses on establishing an effective brand image in the mind of customers.
According to the point of view of Joshua Kennon capital structure play an significant role
in business firm, with the help of this structure organisation can easily manage their capital and
invest them as per the current and future requirements of company. Equity capital and debt
capital are the major type of capitals and they are having their own drawbacks and benefits.
The form of capital are described as under:
Equity capital:
It can be considered as the money that is owned by the owners and stakeholder. Equity
capital can be classified in to two part such as contributed capital and retained earnings.
Contributed capital: It refers as the amount of capital and money which is spend by
company in respect of exchange of share stock and ownership. This play a very vast role in an
organisation, in this company invest huge amount of money to generating profit through spend in
shares and stocks (Ahmed Sheikh and Wang, 2011).
Retained earning: It refers to the profit which is explains the earned profit from the past
years. Company use the balance sheet as a strength of firm with the help of acquisitions, fund
growth and expansion. In this process company retain their profit on the basis of their past profit
and revenue. Balance sheet has been prepared as per the description of past year balance sheet.
The equity capital are termed as most exclusive forms of capital which a company can use
because its cost of return that the firm gain attract huge investment. Companies are focused on
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earning sustainable profit in respect of effective running of business activities for long time
purpose.
Debt capital:
It is also an essential part of capital structure, it can be considered as the money which is
borrowed by other resources in respect of completing all business activities which are important
in generating profit and growth. Long term bonds are considered as most safe kind of capital,
because the activities of business are establish for the purpose of long run and in this situation
company is not able to paying the whole borrowed amount than they paying a cited amount of
interest in the desired period of time (Dalal, 2013).
Short term debts are considered as a commercial paper which is measured by giants. The actual
cost of debt capital is the structure of capital is based on the fitness of organisational balance
sheet. A well reputed company is able to take huge amount of debts form the various resources in
order to effectively completion of business operations to generating more growth and profit for
firm. Debt is the major aspect which helps in increasing companies capital in the place of capital
market. An organisation mainly hire a person as a financial manager who is having a significant
knowledge about the finance and capital and know how to manage these sources in an
organisation. The financial manage is responsible for all activities related with capital, in a
capital structure, each type of capital are varies vastly on the basis of case by case and falls down
the skills and ability of manager in an organisation.
According to the point of view of Richard Loth companies balance sheet play an essential
role in handling capital resource of company which are providing help in each activity of firm
that are related with finance and capital. The actual fitness of companies balance sheet can be
evaluated by some major terms which are classified in to three aspects such as working capital,
capital adequacy and capital structure. There are different kid of investors are available at market
place who are invest money as per their own convenience and benefits. The investment amount
is based on the available capital resources to an individual or organisation. As per the opinion of
middle class investor , the major goal of life is to be free from debt. When an individual or firm
reach at the top grating of finance in this situation that thought is less straightforward. Most of
the large as well as small business enterprises establish their capital structure on the basis of cost
of capital (Xu, 2012). If the companies cost and sales structures are relatively stable than it is
required for company to take a wise step to considered at least 40 to 50 percent in their debt
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capital. A good manager is always concern towards decreasing their cost of weighted average
with the help of increasing their productivity which leads to the higher return goods. This is the
most essential step an organisation often view widely profitable customers groups, with the help
of issuing corporate bonds an organisation can easily take the beneficial advantage of long-term
debts. For creating an effective understanding of capital structure it is required for firm to take an
effective step to read the return on equity (Salim and Yadav, 2012). The company needs to take
Dupont model into proper consideration in order to gain a proper detail about how an
organisation earn profit on a capital which is invested by them to gain rate of return. The
knowledge of manager can increase with the help of increasing the understanding of risk factors
which are faced by the company in terms of money.
As per the opinion of Albert Einstein capital structure is the independent aspect of
business in which various activities related with finance and capital are involved. Capital
structure consist as the outstanding debt and equity of company, it provide support to a company
for creating better understanding about what kind of funds are need to be uses to finance for
overall activities and growth for firm which helps to reach at higher profitable position. It helps
in show the proportions that are related with senior debt subordinate debt and equity in the
resource of funds. The major purpose of creating capital structure is to give an over all
description of the different level of companies risk. According to the rule of thumb, how much
an organisation having the higher debt financing, it helps in exposures the risk of firm. An
organisations capital structure represents how its assets and equipments are financed, company
avoid risk of debt at the time of financing its operations through opening up or developing
money to a spender. For reducing the potential of investment a company will go to the situation
of bankrupt, so it is necessary for owner to maintain debt funding in order to create a control
over company and its activities. This also helps in increasing actual return on the operations.
Debts take the type of issues related with corporate bond, short term debts and long term loans
(Graham, Leary and Roberts, 2015). These all directly affects th working capital of firm. For
managing a favourable ratio of equity it is essential for an organisation to handling debt and
equity which helps in attracting investors in the business firm.
As per the view of Kateri Zhu , she is the famous viewer of capital structure. According
to her point of view a companies effective structure of capital is based on the important choice of
firm. As per the technical perspectives, the structure of capital can be considered as the careful
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balance among debt and equity which is used by a company to purchase its assets, expenses of
their day to day operations and future success and growth.
Debt to equity ratio as a measure of capital structure:
These two elements are found in balance sheet as an important points. The total assets
which are mentioned on the balance sheet are purchased with the help of debt and equity. The
company which are having an aggressive capital structure are always use debt and equity for
paying money for assets that are having very high range of leverage ratio. And the companies
who are finances assets with large equity than debts having a low leverage ratio, these type of
firs are having conservative capital structure. The companies higher growth and success is based
on the high range of leverage ratio or an aggressive structure of capital. Thus the lower growth
rate of firm is depend on the conservative capital structure. The major role of company is to find
out the optimal mix of equity and debt , which helps in generating optimal capital structure for an
organisation in order to provide them long term benefits (De Jong, Verbeek and Verwijmeren,
2011).
The evaluators use equity and debt ration in respect of compare the structure of capital. It
is calculated through dividing debt from equity. Many companies have to studied to incorporate
from debt and equity in to their strategies that are related with corporate. An investor is
responsible to monitor the structure of capital through tracking the equity and debt ratio. It is
necessary to compare the debt and equity to companies peers in order to evaluate the actual profit
and loss situation. Debt and equity ratio is used by company to identify its actual leverage
through dividing firms actual liabilities with the equity of its stakeholder.
Optimal capital structure:
An organisation having two different ways to reaching at optimal capital structure.
Personal and business related ways that are helps in identifying optimal capital structure. A
director or chief executive officer are not having any kind of debt in their personal life, thus their
company use debt in order to increasing their profit and revenues. At some situation debt act as a
deformation on earning of firm. The actual optimal capital structure lies among the financial
burden and maximising profitability.
Seeking the optimal capital structure:
The capital structure of every organisation is different from each other, their structure is
based on the size and nature of the business. The manager of an organisation is responsible for
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creating an effective capital structure to manage all financial activities and operations that are
essential for organisational growth and success. The basic aim of ever investor is to believe in
debt free life through which it is easy for an organisation to reach at higher position and create
high range of profit and growth. The total financial decision is based on the organisational capital
structure, this helps in generating actual profit and loss for company and provide support to
financial manager to take an effective decision on it. The financing decision has a directly
impacted on the weighted average cost of capital (Bodie, Kane and Marcus, 2014). It is the
simple average of cost of equity and the actual cot of debt that are incurred in an organisation to
effective operation of every activity. If the company change its structure of capital than its
directly influence the total output of weighted average cost of capital. The organisations are
focused on preparing a good and well maintained balance sheet in respect of measuring the all
aspects that are involved in this. In the balance sheet the financial manager take the detail of all
assets, equity and debts which are used in a desired financial year. Investor are invest huge
amount of money after measuring the balance sheet of company for the purpose of security. The
balance sheet shows the actual position, profit and growth of company.
CONCLUSION
A per the above report it has been concluded that capital structure play an essential role in
each activity of business. It is necessary for an organisation to establish capital structure in order
to maintain business activities and its operations on order to generating profit and revenue for
long run of business and its all activities. It helps in handling all aspects which are related with
finance and capital. An organisation take debt form various different sources to increasing their
rate of capital to complete each activity of business that are creating growth and success for firm.
High capital is the strength for company, so firms are mainly focuses on maximising profit and
growth in respect of reaching at higher position at market place.
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REFRENCES
Books and Journals
Ahmed Sheikh, N. and Wang, Z., 2011. Determinants of capital structure: An empirical study of
firms in manufacturing industry of Pakistan. Managerial Finance. 37(2). pp.117-133.
Albul, B., Jaffee, D.M. and Tchistyi, A., 2015. Contingent convertible bonds and capital structure
decisions.
Bodie, Z., Kane, A. and Marcus, A. J., 2014. Investments, 10e. McGraw-Hill Education.
Boot, A.W. and Thakor, A.V., 2011. Managerial autonomy, allocation of control rights, and
optimal capital structure. The Review of Financial Studies. 24(10). pp.3434-3485.
Dalal, G., 2013. Optimal capital structure. International Journal of Education and Management
Studies. 3(1). p.138.
De Jong, A., Verbeek, M. and Verwijmeren, P., 2011. Firms’ debt–equity decisions when the
static tradeoff theory and the pecking order theory disagree. Journal of Banking &
Finance. 35(5). pp.1303-1314.
Graham, J. R., Leary, M. T. and Roberts, M. R., 2015. A century of capital structure: The
leveraging of corporate America. Journal of Financial Economics. 118(3). pp.658-683.
Hackbarth, D. and Mauer, D.C., 2011. Optimal priority structure, capital structure, and
investment. The Review of Financial Studies. 25(3). pp.747-796.
Khan, A.G., 2012. The relationship of capital structure decisions with firm performance: A study
of the engineering sector of Pakistan. International Journal of Accounting and
Financial Reporting. 2(1). p.245.
Salim, M. and Yadav, R., 2012. Capital structure and firm performance: Evidence from
Malaysian listed companies. Procedia-Social and Behavioral Sciences. 65. pp.156-166.
Xu, J., 2012. Profitability and capital structure: Evidence from import penetration. Journal of
Financial Economics. 106(2). pp.427-446.
Online
What is capital structure. 2017. [Online]. Available through: <http://www.axial.net/forum/why-
capital-structure-matters/>. [Accessed on 18th August 2017].
Why capital structure matters for organisation. 2017. [Online]. Available through:
<https://www.thebalance.com/an-introduction-to-capital-structure-357496>. [Accessed
on 18th August 2017].
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