Page 1 - Lesson Note 4

SAI INTERNATIONAL SCHOOL

CLASSS XII

SUBJECT: BUSINESS STUDIES

CHAPTER -9, FINANCIAL MANAGEMENT

Topics: Capital Structure, Financial leverage, Factors

(Lesson-33)

Capital structure

Capital structure represents the proportion of debt and equity used for financing
the operation of business. In other words, capital structure represents the

proportion of debt capital and equity capital structure. What kind of capital
structure is best for a firm is very difficult to define. The capital structure should

be such which increases the value of equity share of maximizes the wealth of
equity shareholders.

Debt and equity differ in cost and risk. AS debt involves less cost but it is very risky
securities whereas equity are expensive securities but these securities from

companies point of view.

Debt risky because payment of regular interest on debt is a legal obligation of the

business. In case they fail to pay debt security holders can claim over the assets of

the company and if firm fails to meet return of principal amount it can even go to
liquidation and stage of insolvency.

Equity securities are safe securities from company’s point of view as company has
no legal obligation to pay dividend to equity shareholders if it is running in loss

but these are expensive securities.

Capital structure of the business affects the profitability and financial risk. A best

capital structure is the one which results in maximizing the value of equity
shareholder or which brings rise in the price of equity shares.