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Determinants of Capital Structure

Yesterday, we have taught the steps of determination of optimal capital structure. Except these steps, finance manager thinks about many other factors which affects the capital structure of a company. All these factors can be shown in the following list of determinants of capital structure.


1. Sales of Company 

Sales directly affects the capital structure of company. If there is a big company who can sell large quantity within one day, that company can keep more proportion of debt and less proportion of capital in his capital structure because such companies are of big size. They can get more capacity for repaying the loan without any problem. I can give the example of soft drink, its sale is summer season. So, all financial company can give the loan to soft drink companies because they know that sale of soft drink company is enough to repay the loan during the sale season time.

2. Profitability

Profitability is the second determinants of capital structure. Debt and equity will be decided on the basis of profitability. If company has power to control its expenses and earn more from its sale, then company can use more debt resources in the capital structure. Because there is positive relationship between increasing of profitability and debt. Creditors love interest on their given loan. If company has enough profit to pay the interest on the time, all creditors will give loan with full of happiness. If you do not get enough profit out of sale, you have to keep capital in your capital structure, because you need not give fixed interest to shareholders.

3. Physical Assets

If you have more assets in physical form, you can get more loan on these assets' security. So, you can benefit from this leverage. I think, there are very few financial companies who provide loan on intangible assets because to sell intangible assets is not so easy like selling of tangible assets. If you have not enough tangible assets, you should grow this by keeping more proportion on capital in your debt equity ratio.

4. Taxation

Do you know, you can save tax if you pay the interest? Very simple, because interest is deducted out of total incomes before charging tax. So, on less income, you will pay less tax. If there is high tax rate in your country, you can save tax by keeping more proportion of debt in your capital structure. Due to this, your earning per share will be highest.

5.  Risk of Bankruptcy

If your financial position is not good and there is big chance of your bankruptcy. At that time, to increase the debt is not intelligence. You should pay your debt as soon as possible because it will increase your capital proportion. You can save compulsory interest payment. When this risk will get out, you can increase the debt proportion in your capital structure.

We are showing following infographics in which you can understand more clearly what are the causes of making capital structure


Related : How to Determine Optimal Capital Structure

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Accounting Education: Determinants of Capital Structure
Determinants of Capital Structure
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