CAPITAL STRUCTURE

The capital structure of a firm is the proportion of capital that is obtained through debts versus the capital obtained through equity. Through the study of three different companies’ financial statements, there were three different types of capital structure for the companies. The structures are discussed below.

The first company used the debt ratio capital structure. This structure compares the total assets to the total liabilities of the company. In this structure more of total liabilities compared to total assets mean less equity and therefore the company is highly leveraged. The problem of using this capital structure in financial statement is that it gives equal weight to operational and debt liabilities. The company had assets totaling $1,232,600 and liabilities totaling $ 469,250. Therefore the percentage debt ratio = 469,250/1,232,600 x 100% = 38.07 %. This is a relatively low debt ratio and it means will be able to pay back its debts.

The second company used the debt/equity ratios capital structure. This capital structure compares total liabilities to total shareholder’s equity. For this capital structure, the operational liabilities are debts that will be with the company as long as it exists. A low percentage of the debt to equity ratio means the company has a strong equity position. This company’s total liabilities were $3,560,000 and the shareholders equity was $11,920,400. The percentage debt equity ratio is $3,560,000/$11,920,400 x 100% = 29.86%.

The third company used the capitalization ratio capital structure. This capital structure compares the debt component of a firm to its equity component. The debt component is the total obligations added to the total shareholders’ equity. As the other capital structure ratios, a low percentage means a strong equity position. The company’s short term debts were $922,000, the long term debts $ $2,305,200 and the share holders equity was $5,450,000.

Debt equity ratio = ($922,000 + $2,305,200)/ $ 5,450,000 = 0.59 or 59%

Long term debt to capitalization = $2,305,200/($2,305,200 + $5,450,000) = 0.30 or 30%

Total debt to capitalization = ($922,000 + $2,305,200)/ ($922,000+$2,305,200 + $5,450,000) = 0.37 or 37%

The percentage of annual interest on debt for the third company is stated as 6%.  This is equitable and fair because the percentage is low and this means that the company is paying a low interest expense compared to the total debt of the company annually (Swanson & Srinidhi, 2003).

 

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