The Components of the Capital Structure

A guide for a new investor on capital structure and a look at how the assets on the balance sheet are fund, and why that matters. It is how a firm finances its overall operations and growth by using different sources of funds.

Long term debt

the amount of debt in the balance sheet will show the magnitude of the loan capital use in company operations. This loan can be either a capital debt short term or long term debt, but generally long-term loans is far greater than the short-term debt.

"long-term debt is one of the forms of long-term funding with maturity of over one year, usually 5-20 years". Long term loan debt can be futures loans (loans use to finance working capital needs permanent, to pay off other debts, or buying machinery and equipment) and the issuance of bonds (debt obtain through the sale of bonds, letters in bonds determine nominal value, interest per year, and the bond repayment period).

Measuring the magnitude of the company's assets are finance by creditors (debt ratio) is done by dividing the total long term debt with a total asset. The higher the debt ratio, the greater the amount of capital loans use in generating profits for the company.

A few things into consideration so that the management chose to use debt is as follows:

1. The cost of debt is limit, although the company gain profit great, the amount of interest that is paid a fix magnitude.


2. Expect results are lower than common stock


3. There is no change of control over the company when financing wear debt.


4. Interest payments is the cost burden that could reduce taxes


5. Flexibility in financial structure can be achieve by incorporating rules of redemption of the bonds.

The lender (investor) prefers infusing the investment in the form of long term debt due some consideration. The selection of the investment in the form of long-term debt from the side of the investors is base on the following:

1. A debt can give priority both in terms of revenue as well as the liquidation to the holder.


2. Have a definite maturity.


3. Contents of the agreement are protect by long term debt (in terms of risk).


4. The holder of a fix -obtain a refund (except for income bonds).

Own Capital

In a conservative capital structure, capital arrangement focuses on private equity. Because of the consideration that the use of debt financing in enterprise risk greater than with the use of own capital. "private equity/equity capital is the company's long-term funds provide by the owner of the company (shareholders), which consists of various types of shares (prefer stock and common stock) as well as profit was detain ".

Funding with private equity will cause the opportunity cost. The advantage of having the shares of the company for the owner is control against the company. However, the resulting return of shares does not definitely and shareholders is the first party that bore the risk of the company. Own capital or equity is a long-term capital earn from company owners or shareholders. Private equity is expect to remain in the company for an unlimited period of time while the capital loans with maturity. There are two main sources of own capital:

Preferred stock

preferred stock gives its shareholders several privileges which make it more senior or takes precedence over shareholders the ordinary. Therefore, the company does not provide the prefer stock in great numbers.  Some of the advantages the use of preferred stock for management is as follows:

1. Have the ability to increase the influence of finance.


2. Versatile because preferred stock allows the Publisher to stay in position without delay take the risk to impose. If efforts are lethargic with do not share the interest or pay anyway.


3. Can be use in corporate restructuring, merger, purchase of shares by the company with payment through the new debt and divestitures.

Ordinary share capital

Owner of the company is the holder of common shares who invest his money with the expectation gets returns in the future. Holders of common stock are sometimes call residual owners because they only receive the remaining after all claims upon income and assets have been met.

There are several advantages of financing with common stock for the benefit of management are:

1. The common stock does not give dividends anyway. If the company can gain profit, ordinary shareholders will receive a dividend. But contrary to the interest of bonds which is fix. (was a fixed cost for the company). The company is not require by law to pay dividends to ordinary shareholders.


2. Common Stock does not have a due date.


3. Since the common stock provides the grounding receptacle over the loss suffer the creditors. Then the sale of common stock would increase the credibility of the company.


4. Common Stock may, at certain times, sold more easily than other forms of debt. Common stock has an attraction for certain investor groups. Because (A) may give a higher return compare to other forms of debt or preferred stock; and. (B) represent the ownership of common shares of the company, providing the investors protection against inflation fortress better than prefer stock or bonds. Generally, common stock increase in value if the value of real assets also increased during periods of inflation.


5. Return obtain in ordinary shares in the form of capital gains income tax rates is an object that is low. (Weston & Copeland), "the owner of the deposit insurer risk capital will be the first. It means that a non-party owner will not suffer losses before the liability of the owner end entirely.

The losses of the company must first be charge to the owner. In terms of investors, the advantages of using shares (private equity) are as follows:

1. Have voting rights (control) within the company.


2. There is no maturity.


3. Because of the greater risk, then compensation for the holders of private equity is higher than the loan capital holders.