Question

Please research and then discuss the aspects of the bankruptcy process. Also, discuss capital structure and how a company's structure impacts its progress through the bankruptcy process.

Answer 1

Answer :- Capital structure means the pattern of capital employed in the firm. Capital structure is the permanent long-term financing that is represented by long-term debt, preference share capital, equity share capital and retained earnings. Financial leases may also be included. These are the principal sources of funds that are used to acquire permanent assets. Optimum or balanced capital structure means an ideal combination of borrowed and owned capital that may attain the marginal goal i.e., maximizing of market value of company / firm will be maximized or the cost of capital will be minimized when the real cost of each source of funds is the same. The following factors affect the optimal capital structure of firm / company:-

A). Nature of business :- Each type of business has its own capital or assets structure. Large manufacturing industries have a very high fixed assets base, which serves as security for the issue of debentures. While on the other hand, trading or light industries having a thin base of fixed assets and suffer from income oscillations, have to rely mostly on ordinary and preference share capital.

B). Regularity and Certainty of Income :- Regularity and certainty of income affects capital structure. Debentures are issued if there is certainty of income in future. If funds are needed for some time, then redeemable preference shares may be issued.

C). Desire to control the business :- If the promoters and founders want to control the business then equity shares are issued and large part is kept in the control of a group of some people and rest of the equity capital is diffused in the hands of small investors. When company needs more funds in future, those are obtained through debentures or preference shares.

D). Trading on equity :- If the promoters want to magnify their income they can resort to debt financing and earn more profits. This is known as trading on equity.

E). Future plans :- Future plans should also be kept in view and for this purpose authorized capital should be kept more. Preference shares and debentures should also be part of future plans.

F). Nature and type of investors :- If investors are ready to take more risk, equity issue is better and if they do not want to take more risk, then debentures are most suited.

G). Other factors :- The following are some other factors affecting the optimal capital structure of firm :-

   i). Cost of capital of each source of finance (debt and equity)

ii). Conditions of capital market.

iii). Legal requirements.

iv). Attitude of management.

v). Operating ratio.

While determining the optimal combination of the various sources of finance (debt, equity etc) i.e., in deciding the optimal capital structure of company, a due consideration should be given to the solvency of company / firm. If the excessive debt threatens the solvency of company then there can be situation of bankruptcy for company in near future. Thereby, An optimum combination of borrowed fund (debt, loans) and owned funds (equity) should be structured in the capital structure of company. In short, Capital structure of company impacts the progress and growth of company to a great extent and if the capital structure is not ideal / optimum then the business operations of company will shut down or company will enter in bankruptcy stage in the upcoming future.