American Public University
Capital structure has an essential place for making a business sustainable today and in the future. The capital structure reflects all the firm's debt and equity obligations. A company might create a capital structure consisting of different capital resources with different risk levels. The components of the capital structure include the followings: senior debt, subordinated debt, mezzanine debt, hybrid financing, convertible debt, convertible equity, preferred equity, and common equity. While creating and managing the capital structure, making decisions on the preference of use the mentioned components has high importance, because each element has a risk level for creating sustainable business regarding finance. At the short term, a business has to provide enough elasticity in liquidity; therefore, the company does not have any difficulty to run for the near future. In the long run, the company needs to raise the amount of the capital to make new investments into the desired fields to grow the business.
The equities are the financial resources provided by the shareholders to raise the capital. The assets cannot provide enough liquidity to the company because the shareholders do not provide financial resources in the short run. However, debts are more controllable in the near term, and they can be used for managing the required liquidity for the company. The equities are less risky for using as financial resource because the equities belong to the shareholders and can be utilized more elastically compared to the other financial resources. However, the debts are provided for the financial institutions, and they have a cost of use, and there always exists the risk of the early payment request by the financial institutions. Also, the increasing interest rates due to the macroeconomic situation in the economy might increase the amount of debt for the company (Dewaelheyns and Van Hulle, 2008, p.346).
Finally, the decision of forming capital structure has to be done very carefully depending on the essentials of the particular business and many other factors. If the company works in a relatively riskier industry which requires the high level of liquidity, the company might need to use more debts relatively. If the company does not require a high level of liquidity, increasing a number of equities in the company's capital structure might be a relatively healthier situation for the company (Dewaelheyns and Van Hulle, 2008, p.347)
(Dewaelheyns and Van Hulle, 2008, p.346)
Reference
Dewaelheyns, N. & Van Hulle, C. (2008). Internal Capital Markets and Capital Structure: Bank Versus Internal Debt. European Financial Management, 16(3), 345-373. http://dx.doi.org/10.1111/j.1468-036x.2008.00457.x
