The capital structure is how a firm finances its overall operations and growth by using different sources of funds. The optimum capital structure indicates the best debt-to-equity ratio for a firm that maximizes its value. It is a financial measurement that firms use to find out the best mix of debt and equity financing to use for operations and expansions.
There are some factors determining the optimum capital structure of an enterprise. These are as follows:
- Nature of business: The nature of business itself is one of the factors determining a capital structure to be maintained.
- Size of the company: Small enterprises have to rely less on borrowed capital and depend more on owner’s capital.
- Trading on equity: In case of trading on equity, there is greater dependence on borrowed capital in the capital structure.
- Cash flows: The more the cash inflows, more wilt be the amount (Ask) of borrowed capital in the overall capital structure and vice-versa.
- The purpose of financing: The purpose of financing also affects the capital structure of the enterprise.
- The condition of the future: The scope of changing the capital structure in future is another basic consideration for determining capital the capital structure of an enterprise.
So, these are the various factors determining the optimum capital structure of an enterprise.