What is the Importance of Capital Structure?

The importance of capital structure is as follows:

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• Increase in the value of the firm

A proper capital structure of a company helps in increasing the market price of the shares and securities that, in turn, will lead to an increase in the value of the company.

• Utilizing the available funds

An organized capital structure permits a business to utilize the available funds completely. An appropriately planned capital structure guarantees the assurance of the money related necessities of the firm and raises the assets in such extents from different hotspots for their most ideal use. A sound capital structure shields the business venture from over-capitalization and under-capitalization.

• Maximization of return

A sound capital structure empowers the board to expand the benefits of an organization as better yield to the value investors, i.e., increment in income per share. This should be possible by the system of exchanging on value, i.e., it alludes to increment in the extent of obligation capital in the capital structure, which is the least expensive wellspring of capital. In the event that the pace of profit for capital utilized surpasses the fixed pace of premium paid to obligation holders, the organization is supposed to exchange on value.

• Minimizing the cost of capital

A sound capital structure of any business undertaking expands investors' riches through the minimization of the usual expense of capital. This must likewise be possible by joining long term debt capital in the capital structure as the expense of debt capital is lower than the expense of value or inclination share capital since the enthusiasm on the obligation is charge deductible.

• Solvency or Liquidity position

A proper capital structure will never allow a business to go for too much raising of debt capital because, during the time of poor earning, the solvency is disturbed for mandatory payment of interest to the supplier of debt.

• Flexibility

A proper capital structure gives room for expansion or reduction of the debt capital so that, as per the changing conditions, the adjustment of capital can be made.

• Undisturbed controlling

A better capital structure does not permit the equity shareholders' control on business that is to be diluted.

• Minimization of financial risk

In the event that obligation part increments in the capital structure of an organization, the budgetary hazard will likewise increment. A sound capital structure shields a business endeavour from such monetary hazard through a wise blend of obligation and value in the capital structure.

What is Capital Structure, Financial Structure, and Assets Structure?

The term capital structure is different from the financial structure and assets structure. 

Financial structure consists of long-term debt, short-term debt, and shareholder's fund, i.e., the complete left-hand side of the company’s balance sheet. 

Capital structure includes long term debt and the shareholders’ fund.

Hence, capital structure is different from the financial structure. It is a portion of the financial structure. 

The capital structure does not include short-term liabilities, whereas financial structure includes short-term liabilities or current liabilities.

Assets structure signifies the composition of total assets used by an organization. It specifies the application of funds in the various types of assets fixed as well as current.

• Assets structure = Fixed Assets + Current Assets.

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• The term capitalization refers to the total amount of long-term funds at the disposal of the company. It did not matter how it was raised. It can be raised from equity shares, preference shares, retained earnings, debentures, or institutional loans.

Capitalization

Capitalization in Finance

In finance, capitalization is the sum of a company’s debt and equity. It represents the capital invested in the company, including bonds and stocks. 

Capitalization can also mean market capitalization. Market capitalization is the value of a company’s outstanding shares of stock and it represents the value of the firm according to investors’ perceptions. It is equal to the number of shares outstanding multiplied by the share price.

Market Capitalization = Shares Outstanding x Share Price

Capitalization in Accounting

In accounting, capitalization refers to recording costs as assets on the balance sheet instead of as expenses on the income statement. A company may record the purchase price of an asset, as well as the asset’s acquisition costs, such as transportation and setup, as assets on the balance sheet.

Capitalization also refers to transferring an off-balance-sheet operating lease onto the balance sheet and recording it as a capital lease. To do this, calculate the present value of the future operating lease payments and record the amount on the balance sheet as an asset with a corresponding liability. 
Capitalization of Cost

For example, a manufacturing company may record the cost of raw materials, direct labor, and overhead as assets – where labor and overhead would be capitalized costs. The assets (including the capitalized costs) are then transferred to the income statement as costs of goods sold as the underlying assets are sold to customers. Capitalizing costs increases the value of total assets and equity on the balance sheet, as well as net income on the income statement. 


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