Definition: R.H. Wessel “The long term sources of funds employed in a business enterprise.”
John H. Hampton “A firm’s capital structure is the relation between the debt and equity securities that make up the firm’s financing of its assets.” Thus, the term capital structure means security mix. It refers to the proportion of different securities raised by a firm for long-term finance.
Components/Parts of Capital Structure:
There are four basic components of capital structure. They are as follows:
(i) Equity Share Capital:
- It is the basic source of financing activities of the business. Equity share capital is provided by equity shareholders.
- They buy equity shares and help a business firm to raise necessary funds. They bear the ultimate risk associated with ownership.
- Equity shares carry dividends at a fluctuating rate depending upon profit.
(ii) Preference Share Capital:
- Preference shares carry preferential rights as to payment of dividends and have priority over equity shares for return of capital when the company is liquidated.
- These shares carry dividends at a fixed rate.
- They enjoy limited voting rights.
(iii) Retained earnings:
- It is an internal source of financing.
- It is nothing but ploughing back of profit.
(iv) Borrowed capital: It comprises of the following:
- Debentures: A debenture is an acknowledgment of a loan raised by the company. The company has to pay interest at an agreed rate.
- Term Loan: Term loans are provided by the bank and other financial institutions. They carry fixed rate of interest.