Discuss the various factors affecting the capital structure.
Even there are actually many of the internal or
external factors that will affect the capital structure, but most of them
can categorize into three main types of factors or element to be considered inside
the capital structure which is the cost element, risk element, and elasticity
element.
👍First categorize of factors: Cost
Firstly, about the cost element as a factor that
affecting the capital structure such as the tax, product cost, rental, and so on.
The increasing cost will also be increasing the debt ratio inside the
capital structure. However, while the debt increase, it also adding the company
value. For example, the amount of the tax especially the income tax will
influence the capital structure. It found that the between the tax and
liabilities could offset each other. Let say if that the company has made more
payment on the interest or debt, it actually reduces the tax that needs to pay.
This is because that the income is reducing after payment of debt so that the
income tax will also decrease, usually the afterward return will also
higher compare to pay more on tax. So that the company with high tax will be encouraged
to have a higher debt ratio, which able to use as tax shields protection. However,
if a company wants to decrease tax using debt, the company must have the
capability to generate enough profit to pay the interest of debt as well.
👍Second categorize of factors: Risk
Secondly, it was about the risk management of a
company. Previously, it discusses the leverage of the capital structure
that brings different risks to the company. While the debt and equity are highly
different, then it has lower risk, while they both are nearly same, they have
higher risk because it would have less amount of available funds for emergency
situation. Based on how the company and its employee’s willing to take
the risk, the capital structure will receive a big influence. The factor that
may affect risk management such as market fluctuations, natural disasters,
competition, financing, fluctuation of the exchange rate, interest rate and etc.
For example, while there was a natural disaster coming, it will decrease the
company profit, so that the debt ratio in the capital structure should be
decreasing to lower the risk of bankruptcy and so on. In opposite, If the sales
will increase, the debt could be also increased for higher afterward return
which is able to bring higher growth to the company, however, it will also bring higher risk.
👍Third categorize of factors: Elasticity
Third categorize of factor which was the elasticity of the capital structure. The elasticity of the capital structure refers to the adjustability, convertibility, adaptability of the capital structure. Usually, the company will hope to have a higher elasticity on its own capital structure. This is because that a higher elasticity of capital structure could help the company the facing most of the emergency situation or sudden changing of the market and so on other risks. For example, the factors that affect elasticity have available funds, the stability of sales and profit, debt repayment period, and restriction on rules and regulation. For example, if the sales and profit were very high, the company would have more available funds for other purposes such as investment and facility, etc. This will give the company a higher elasticity too if suddenly have any changes or emergency. Besides that, if the elasticity was higher, the debt ratio usually will be lower as well. However, usually, after the capital structure has form, the elasticity will relatively reduce and lower.More Info:
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