What is Capital Structure?

A capital structure concerns the composition of the liability of a company or more specifically, the relative participation of the several financing sources in the composition of the total obligations. Capital structure decision is very essential for any organization; every organization desires a mix or arrangements that eventually achieves or increases its profitability and overall value. Capital structure is an arrangement of debt, equity and further resource of financing which are used for endowment of long-term assets. Main contributors of capital structure are debt and equity. Different alternatives are available to companies to finance; for example through issuing shares, securities or debts.  Organizations achieve different combinations of huge or small amount of debts. Every organization tries to have the best combination which increases its efficiency, profitability and market value.

These types of decisions are very difficult in uncertain economy.  In various developing countries, the existence of macro environment factors such as lofty interest rates, volatility in economy and political situations are important factors for the different combination of capital structure. Consequently, the financing decisions experience a significant rise of costs, in addition to the diminution of the economic activity which also raise the uncertainty.

Many theories and practical approaches contributed on capital structure give abundant literature. There are many diverse characteristics that influence a company’s capital structure and a firm must endeavor the optimal or best mix of financing. After analyzing many different factors, a company set up target capital structure, which ultimately becomes its optimal structure. Capital structure entails the substitution between risk and return. With employing the more debt increases the risk level in the companies earning flow. But, a greater amount of debt directs prominent predictable rates of returns. Consequently, equilibrium between risk and return is accomplished by optimal capital structure, which is the ultimate objective of any organization.