Impact of capital structure decision for the development and growth of corporation

There are four primary factors that influence capital structure decision of a corporation.

Those are mentioned below.

Business Risk: Business Risk refers to the chance a business's cash flows are not enough to
cover its operating expenses like cost of goods sold, rent and wages. It is the risk for
which a company will go bankrupt. Every company carries the business risk that it will produ
ce insufficient cash flow in order to maintain operations. In order to avoid business risk,
corporation must use debt capital along with equity capital. Higher the equity capital, higher
the business risk. That’s why if corporation use equity and debt capital in a good balance, it
may minimize the business risk which is inherent in its operation. Many managers say that
60% debt capital and 40% equity capital is a good ratio for a corporation.

Tax Position: Every corporation is bound to pay taxes to the government. Higher the profit
of a corporation, higher the amount of tax is payable to the government. A firm must use
sufficient amount of debt capital in its operation. Because if a firm uses debt capital, it must
pay interest for it and interest is tax deductible. That’s why if a firm wants to minimize its tax
payment cost, it must take loan for its operation. Again, higher the tax rate, lower the
business risk. As far as interest is concerned it is no doubt a deductible expense which is
much valuable to firms with high tax rates. This is the reason that many firms use much debt
because if firm’s tax rate is higher the advantage is also greater.

Financial Flexibility: Financial flexibility has also impact on capital structure decision. A
firm or company makes the decision according to its financial flexibility. If a company is
financially good it can raise capital with either stock or bond. But when its financial position
is weak the suppliers of capital make funds available if the company gives them a secure
position in shape of debt. Seeking all above thoughts in mind it can be said that the
companies should maintain the financial flexibility or adequate reserve borrowing capacity
because it depends on the factors which are necessary in making capital structure decisions

Managerial Attitude: Different management attitudes may bring different changes in capital
structure decisions. Management may be conservatives or aggressive depending upon the
attitude towards risk taking. Both managerial styles exercise according to their own
judgments and analytical approaches about the proper capital structure. If the management
attitude is conservative it uses less debt, where if the management is having aggressive
approach then it uses more debt to get higher profits.