Page 85 - DMGT409Basic Financial Management

Basic Financial Management Nancy Sahni, Lovely Professional University

Notes Unit 5: Capital Structure Decisions

CONTENTS

Objectives
Introduction
5.1 Meaning of Capital Structure
5.2 Forms of Capital Structure
5.3 Factors Determining the Capital Structure

5.4 Concept of Leverage
5.4.1 Operating Leverage
5.4.2 Financial Leverage
5.5 Summary

5.6 Keywords
5.7 Self Assessment
5.8 Review Questions
5.9 Further Readings

Objectives

After studying this unit, you will be able to:

Discuss concept of capital structure
Know about debt and equity
Describe Leverage

Introduction

Every organisation requires funds to run and maintain its business. The required funds may be
raised from short-term sources or long-term sources or a combination both the sources of funds,
so as to equip itself with an appropriate combination of fixed assets and current assets. Current

assets to a considerable extent are financed with the help of short-term sources. Normally,

firms are expected to follow a prudent financial policy, as revealed in the maintenance of net
current assets. This net positive current asset must be financed by long-term sources. Hence,

long-term sources of funds are required to finance for both (a) long-term assets (fi xed assets)

and (b) networking capital (positive current assets). The long-term fi nancial strength as well as

profitability of a firm is influenced by its fi nancial structure.
?
Did u know? The term ‘Financial Structure’ refers to the left hand side of the balance sheet as
represented by “total liabilities” consisting of current liabilities, long-term debt, preference
share and equity share capital. The financial structure, therefore, includes both short-term

and long-term sources of funds.

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