An Understanding Of Capital Gearing & Trading On Equity

“After heavy monetary crunches in the financial system, for a corporate entity, it is quite significant to have a perfect mix of various capital sources to make sure good returns and overcome from the depth of losses.”

Here, some essential phrases have been defined close to the financial system of a company:

CAPITAL STRUCTURE

The types of securities to be issued and proportionate amounts that make up the capitalization is named capital structure or monetary structure.

Capital structure refers to the proportion of various sorts of securities issued by an organization to lift lengthy-term finance. Thus capital structure denotes: (1) the types of securities issued (equity shares, preference shares and debentures), and (ii) the relative proportion of every type of security. In different words, capital structure represents the proportion of equity capital and dept capital used for financing the operations of a business. Proper balance should be obtained in the following securities or sources of finance to maximise the wealth of the equity shareholders of the company:

(a) equality shares,

(b) desire shares, and

(c) debentures

Options of Sound Capital Construction

An organization’s capital structure is said to be optimum when the proportion of debt and equity is such that it ends in maximizing the return for the Physician Equity shareholders. Such a structure would differ from company to firm depending upon the nature and dimension of operations, availability of funds from completely different sources, effectivity of management, etc.

A SOUND CAPITAL STRUCTURE SHOULD POSSESS THE FOLLOWING FEATURES:

(i) MAXIMUM RETURNS.

(ii) LESS RISKY.

(iii) FLEXIBILITY

(iv) ECONOMY.

(v) DYNAMIC.

FINANCIAL LEVERAGE OR CAPITAL GEARING

An organization can increase capital by issuing three types of securities: (a) equity shares, (b) choice shares, and (c) debentures. Preference shares carry a fixed rate of dividend and debentures carry a fixed rate of interest. The equity shares are paid dividend out of profits left after fee of curiosity on debentures, and dividend on choice shares. Thus, dividend on equity shares could range 12 months after year. Equity shares are referred to as variable return securities and debentures and preference shares as fixed return securities. If the rate of return on fixed return securities is decrease than the rate of earnings of the company, the return on equity shares will be higher. This phenomenon is named financial leverage or capital gearing.

Thus, financial leverage is an arrangement beneath which fixed return bearing securities (debentures and preference shares) are used to lift cheaper funds to increase the return to equity shareholders. It may be noted that a lever is used to lift something heavy by applying less pressure than required otherwise.

Capital gearing denotes the ratio between varied types of securities and total capitalisation. Capitalisation of an organization is highly geared when the proportion of equity to total capitalization is small and it is low geared when the equity capital dominates the capital structure.