Financial Management — Part 2: Capital Structure, Fixed and Working Capital: visual lesson, CBSE Class 12 Business Studies

Lesson

Capital structure and the need for capital

Part 2 — the mix of debt and equity, trading on equity, and how much fixed and working capital a business needs.

In this lesson you will

Explain capital structure, financial risk and trading on equity with a worked EPS calculation
Explain the factors affecting the choice of capital structure
Explain fixed and working capital and the factors affecting each

Part 2 at a glance

Compare

Capital structure is the proportion of debt and equity in the long-term funds of a business.

Debt: cheaper, fixed obligation, more financial risk, no dilution of control.

Equity: costlier, no fixed obligation, less financial risk, may dilute control.

Capital structure = the mix of these two.
	Debt (borrowed funds)	Equity (owners' funds)
Return to providers	Fixed interest, must be paid	Dividend, at the board's discretion
Cost to company	Lower (interest is tax-deductible)	Higher (owners expect more)
Risk to company	Higher: default can lead to legal action	Lower: no fixed obligation
Control	No voting rights for lenders	New shares may dilute control

Concept

Financial risk is the chance that a company cannot meet its fixed payments on debt.