Question

How about the Capital sturcture of the companies in different industry?

why the Capital sturcture on the company in the different industrisy??(different or various )

Answer 1

Ans. For the clear understanding of the topic, let us first understand what capital structure means and how does it affects the income or valuation of a firm's stock. Capital structure in short is how a company finances its investment needs through different sources of finance. One need to take into account that, the optimal capital structure for a firm would be the mix of different sources from which it borrows and it provides the lowest cost of capital to the firm without taking too much risks. To make it simple, we mainly consider two types of sources of funds from where financing activities are conducted by the company.

1) Debt - debt is the type of financing which incurs lowest cost of capital to the firm. It also gives tax advantage by making the interest payable on the loans tax deductible. Long term debts like bonds, debentures, and short term debts like commercial papers and certificate of deposits are the examples of debt financing. but there is a catch, creditors who give the loans as debts need to be paid back even if the firm's income decline. They have the right to drag the firm to insolvency and liquidation if the interest payments are not made in time. So, although debt is lower in cost, it increases the risk for the firm.

2) Equity- Equity is the type of financing where the company raises its funds for investment needs through existing or new shareholders. The cost of equity capital is much higher than the debt as the shareholders invest in a firm to earn sufficient returns as the shareholder is getting the ownership of the firm proportionately through his investment. Initial public offering (IPO), further public offer (FPO), Rights issue and private placements are examples of equity financing. But, even if equity financing has larger cost impact on the firm and no tax advantage, there is a big advantage for equity financing that even if the company incurs losses or profits, the right to distribute the share of profit to the shareholders remains with the company. They may deny any dividend distribution and keep the profits under retained earnings for future investment needs.

So, both the debt and the equity has its own advantages and disadvantages. An optimal capital structure would be the combination of both debt and equity which will optimise the risk and overall cost of capital for the firm.

As, per the question a manufacturing firm or a firm with heavy investments in plants and machinery looking for long term investment would go for debt financing. typically, manufacturing industries has large amount of debts in there capital structure as they cannot raise so huge some of money only by equity.

while service industries like Information Technology and other service providers generally have lower initial investment to make as they dont require huge plant, machinery, equipments and labour. So, they go for equity which allows them to have the flexibility of paying/not paying out the shareholders. Some IT companies even have zero debt in their capital structure.

So, it depends on the factors like investment sum, gestation period to break-even, growth opportunity, need for long term funds etc to determine the optimal mix of Debt and Equity in the capital structure of the firm.