An Understanding Of Capital Gearing & Trading On Equity

“After heavy financial crunches within the financial system, for a corporate entity, it’s fairly vital to have an ideal mix of varied capital sources to make sure good returns and overcome from the depth of losses.”

Here, some crucial terms have been defined with reference to the financial system of a company:

CAPITAL STRUCTURE

The types of securities to be issued and proportionate amounts that make up the capitalization is named capital construction or monetary structure.

Capital structure refers to the proportion of different sorts of securities issued by an organization to raise long-time period finance. Thus capital structure denotes: (1) the types of securities issued (equity shares, desire shares and debentures), and (ii) the relative proportion of each type of security. In other words, capital construction represents the proportion of equity capital and dept capital used for financing the operations of a business. Proper balance should be obtained within the following securities or sources of finance to maximise the wealth of the Physician Private Equity shareholders of the company:

(a) equality shares,

(b) desire shares, and

(c) debentures

Options of Sound Capital Construction

An organization’s capital construction is alleged to be optimum when the proportion of debt and equity is such that it results in maximizing the return for the equity shareholders. Such a construction would vary from company to company relying upon the nature and measurement of operations, availability of funds from different sources, efficiency of administration, etc.

A SOUND CAPITAL STRUCTURE SHOULD POSSESS THE FOLLOWING FEATURES:

(i) MAXIMUM RETURNS.

(ii) LESS RISKY.

(iii) FLEXIBILITY

(iv) ECONOMY.

(v) DYNAMIC.

FINANCIAL LEVERAGE OR CAPITAL GEARING

A company can elevate capital by issuing three types of securities: (a) equity shares, (b) choice shares, and (c) debentures. Preference shares carry a fixed rate of dividend and debentures carry a fixed rate of interest. The equity shares are paid dividend out of earnings left after fee of interest on debentures, and dividend on desire shares. Thus, dividend on equity shares could range year after year. Equity shares are often known as variable return securities and debentures and desire shares as fixed return securities. If the rate of return on fixed return securities is decrease than the rate of earnings of the corporate, the return on equity shares might be higher. This phenomenon is called financial leverage or capital gearing.

Thus, monetary leverage is an arrangement below which fixed return bearing securities (debentures and preference shares) are used to lift cheaper funds to increase the return to equity shareholders. It might be noted that a lever is used to lift something heavy by making use of less pressure than required otherwise.

Capital gearing denotes the ratio between various types of securities and total capitalisation. Capitalisation of an organization is highly geared when the proportion of equity to total capitalization is small and it’s low geared when the equity capital dominates the capital structure.