Q: Describe the capital structure in the context of financial management.

Capital Structure: The capital structure is how a firm finances its overall operations and growth
by using different sources of funds. Simply, capital structure makes up of firm’s capitalization.
In other words, capital structure is the combination of equity capital and debt capital. A company
procures its funds by issuing various types of securities, i.e, ordinary shares, preference shares,
bonds and debentures.
Before issuing any of these securities, a company should think about the kinds of securities to be
issued and in what proportion of the various kinds of securities will be issued. So, in broader
sense, capital structure of goods are all the long-term capital resources like loans, bonds, share
issues, reserve etc. are the components of capital.
A hypothetical capital structure is shown below:
Capital structure
Sources of fund Amount in taka (Crore)
Ordinary share capital 10
8% preference share 5
12% Bonds 2
Reserve 3
Total capital employed Total 20 crore taka

Q: Describe the factors which affected the capital structure.

1. Trading on Equity: It is like a debt capital which creates fixed cost.
2. Desired control: Preference share and debentures have no voting rights; more funds can
be raised through their issue and at the same time control of the company can be retained
by the existing management.
3. Nature of business: The nature of business can have strong effect on the pattern of
capital structure. A business with fixed and regular income can safely rely on debentures
and preference share s which necessitate regular payment of fixed interest & dividends.
4. Purpose of financing:
5. Period of financing:
6. Elasticity of capital structure:
7. Need of investors: It is desirable to issue securities of different kinds to obtain
subscriptions from people with different attitudes and preferences.
8. Cost of financing: The cost of financing differs from security to security. It is relatively high if
financing to raise through the issue of equity shares. Because it necessitates advertisement on a
large scale, payment of underwriting commission and brokerage etc. On the other hand, issue of
debentures necessitates lower expenses as debentures are regarded as safe investment.
9. Market conditions: During boom period the investors will go in for equity shares with the
expectations of high dividends. But in times of depression, they will look more to safety than
income and will be willing to invest in debentures rather than in equity share.
 10. Legal restrictions: The companies have to comply with legal provisions regarding the
different issue.
11. Policy of financial institution: This is important to consider. A change in lending policy
may increase cost of borrowing.
12. Trend of profitability:
13. Possibility of regular and fixed income:

Q: What is balanced capital structure? Describe the features of balanced/ sound capital
structure.
Balanced capital structure means an ideal combination of borrowed and equity share capital
which will attain the financial goal of the business. i.e; profit maximization, minimization of cost
of capital, maximum of market value per share etc.
Features of balanced capital structure / sound capital structure:
1. Profitability
2. Solvency
3. Flexibility
4. Conservation
5. Control
6. Simplicity
7. Economy
8. Attractiveness of investors
9. Balanced leverage
Objectives of balanced capital structure:
1. Cost minimization
2. Minimization of risk
3. Maximization of return
4. Preservation of control
5. Proper liquidity
6. Full utilization of resources
7. Simplicity
8. Flexibility

Q: Describe Capital gearing.

Capital gearing: capital gearing is the proportion of different types of securities to the total
capitalization. Simply, it can be stated that capital gearing is the ratio of equity share capital
to the total capital of company.
Capital gearing may be classified as –
 1. High gearing
2. Low gearing

1. High Gearing

When the amount of equity share capital in the company is less than the Debt capital
and preference share capital, that situation is said to be high gearing.

In other words, when in any company ordinary share capital is less than other fixed
interest-bearing securities, then it’s known as high gearing.

2. Low Gearing

When the amount of equity share capital is more than the amount of debt capital and
preference share capital, then its known as low gearing.

In other words, in the situation when the ratio of equity shares capital is more than
fixed cost bearing securities, it is known as low gearing.

Trading on equity: Trading on equity is an arrangement of equity capital and debt capital.
Trading on Equity is a financial process that involves taking more debt to boost the return of the
shareholders. Trading on Equity occurs when a company takes new debt, in the form of bonds,
preferred stock, or loans etc. The company uses those funds to acquire assets to generate a return
greater than the interest cost of new debt.
Trading on equity – also known as financial leverage – is considered successful if the company
generates a profit and a higher return on investment for the shareholders. Companies, usually, go
for trading on equity (instead of raising capital via issue for shares) to improve their earnings per
share (EPS).