Discuss the four factors that affect Target capital Structure, 1. Business Risk, 2. Tax Position, 3. Financial Flexibility, 4. Managerial Attitude

Different firms have different levels of debt and equity to finance its assets and operations . Businesses have a different levels of this optimum mix , the finding out of which is , as Analia Jones surmised , is not an exact science

A target capital structure strikes a balance between risks and returns with an aim to minimize the cost of capital and maximizes stock price (Business Reference , undated . As Jones explains , higher debt generally leads to a higher risk but also a higher expected returns . However higher risks generally lowers stock price (Jones , undated p

This will be looking at the four factors that influence target capital structure decisions : Business Risk , Tax Position , Financial Flexibility and Managerial Attitude

The Four Factors

Business Risk . Business risk is defined by Investopedia as the risk that a company will not have adequate cash flow to meet its operating expenses (Investopedia , undated . Jones indicates that greater business risk , or more earnings volatility , would not allow for a high level of debt financing . Investopedia adds that if a company relies entirely on equity financing , it would pose no financial risk

Tax Position . Using debt to finance your business is primarily attractive because interest is tax deductible , which lowers the effective cost of debt (Jones , undated . A firm with a higher effective tax rate should consider using more debt

Financial Flexibility . Jones writes that financial flexibity is the "ability to raise capital on reasonable terms under adverse conditions A firm would need ready access to both debt and equity to have a steady stream of capital , which is needed for stable operations . Jones advises that a company issues equity to "strengthen its capital base and financial stability

In general , companies with stable sales , good assets and high growth rates could obtain and use debt more heavily , while companies with high profitability , poor credit ratings or a conservative management can use equity (Encyclopedia of Small Business , undated

Managerial Attitude . While not really an inherent factor to target capital structures , a manager 's aggressiveness or conservatism will influence decisions regarding capital structures . Jones explains that some managers are more inclined to use debt , even with its attendant risks , to boost profits--since debt maximizes the earnings per share Another issue in managerial attitude is control . Relying heavily on equity means management is shared by a lot of shareholders , which would dilute control (Encyclopedia of Small Business , undated

Conclusion

Capital structure decisions are very complex decisions . One has to look at these four factors and weigh it with the business ' status at any given point in time . Determining the optimum levels of debt and equity in your business might be a difficult process , and a political one since at one point or another , management attitudes and styles will clash and create conflict

Note , however , that nothing in this process is set in stone . There will be changes and leeways for failures . The target capital structure will change over time because the factors influencing it will not remain static . The important thing , as...