An Understanding Of Capital Gearing & Trading On Equity

“After heavy financial crunches in the economy, for a corporate entity, it is quite important to have an ideal blend of assorted capital sources to make sure good returns and overcome from the depth of losses.”

Here, some crucial phrases have been defined on the subject of the monetary system of an organization:

CAPITAL STRUCTURE

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

Capital structure refers back to the proportion of different kinds of securities issued by an organization to raise long-time period 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 other words, capital construction represents the proportion of equity capital and dept capital used for financing the operations of a business. Correct balance should be obtained within the following securities or sources of finance to maximise the wealth of the equity shareholders of the corporate:

(a) equality shares,

(b) desire shares, and

(c) debentures

Options of Sound Physician Capital Structure

An organization’s capital structure is said 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 construction would vary from firm to firm depending upon the character and measurement of operations, availability of funds from different sources, effectivity of administration, 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 raise capital by issuing three types of securities: (a) equity shares, (b) preference 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 income left after payment of curiosity on debentures, and dividend on preference shares. Thus, dividend on equity shares could differ yr after year. Equity shares are known as variable return securities and debentures and preference shares as fixed return securities. If the rate of return on fixed return securities is lower than the rate of earnings of the corporate, the return on equity shares might be higher. This phenomenon is called monetary leverage or capital gearing.

Thus, monetary leverage is an arrangement beneath which fixed return bearing securities (debentures and desire 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 making use of less pressure 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’s low geared when the equity capital dominates the capital structure.