An Understanding Of Capital Gearing & Trading On Equity

“After heavy financial crunches within the financial system, for a corporate entity, it’s quite vital to have an ideal blend of various capital sources to make sure good returns and overcome from the depth of losses.”

Here, some crucial phrases have been outlined as regards to the monetary system of an organization:

CAPITAL STRUCTURE

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

Capital structure refers to the proportion of various kinds of securities issued by an organization to boost long-term finance. Thus capital structure denotes: (1) the types of securities issued (equity shares, choice shares and debentures), and (ii) the relative proportion of every type of security. In other words, capital structure represents the proportion of equity capital and dept capital used for financing the operations of a business. Correct balance have to 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

A company’s capital structure is claimed to be optimum when the proportion of debt and equity is such that it results in maximizing the return for the equity shareholders. Such a structure would vary from firm to company relying upon the character and measurement of operations, availability of funds from totally different sources, efficiency 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

A company can raise capital by issuing three types of securities: (a) Physician Private Equity shares, (b) preference shares, and (c) debentures. Choice 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 payment of curiosity on debentures, and dividend on choice shares. Thus, dividend on equity shares might differ yr after year. Equity shares are often known as variable return securities and debentures and choice 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 probably be higher. This phenomenon is named monetary leverage or capital gearing.

Thus, financial leverage is an arrangement below which fixed return bearing securities (debentures and preference shares) are used to boost cheaper funds to extend the return to equity shareholders. It may be noted that a lever is used to lift something heavy by making use of less drive than required otherwise.

Capital gearing denotes the ratio between various types of securities and total capitalisation. Capitalisation of a company 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.