Capital structure refers to the manner that an organization finances or funds its entire business operations and growth (Myers, 2001). Due to certain arising conditions, a company or organization can occasionally be forced to look for financing from different places. It can either be in terms of equity or debt. Therefore, the structure is expressed as either a debt-to-capital ratio or debt-to-equity ratio (Rajan & Zingales, 1995). Ideally, equity and debt capital are used not only to finance capital expenditures and operations of a company, and they can as well be used to make new acquisitions, extend firm activities, and many more investments. For that reason, firms are sometimes obliged to make specific tradeoffs when they opt to raise equity or debt to find an optimal capital structure (Salim & Yadav, 2012).
Capital structure is one of the critical factors that influence firm performance, a critical parameter used to assess the efficiency of the management instruments or approaches applied by the management. According to Le & Phan (2017), the primary goal of a company is to maximize profits and minimize costs. Firm performance can, therefore, be measured by assessing several accounting variables, which are usually calculated from financial statements. This includes things like the return on equity (ROE), the return on assets (ROA), the return on investment (ROI), net profit margin, and many others. Volatility and stock market returns like earnings per share (EPS) are also other essential metrics for assessing the performance of an organization based on its capital structure. Tobin’s Q performance measurement is presently one of the best tools that reflect the mix accounting and market performance (Nassar, 2016). It is represented by the equation below:
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Earnings per Share (EPS) = (Net income-Dividends on preferred stock)
Average outstanding share
In summary, it can be deduced that capital structure is the debt-to-capital ratio or/and the debt-to-equity ratio financial arrangement an organization can use to fund its overall operations. It is one of the critical structures firms can target to measure their business performance using parameters like ROE, ROA, ROI, and EPS.
References
Le, T. P., & Phan, T. B. N. (2017). Capital structure and firm performance: Empirical evidence from a small transition country. Research in International Business Finance, 42, 710-726.
Myers, S. C. (2001). Capital structure. The Journal of Economic Perspectives, 15 (2), 81-102.
Nassar, S. (2016).The impact of capital structure on Financial Performance of the firms: Evidence From Borsa Istanbul. Journal of Bus Financial Affairs, 5 (173). Retrieved from https://www.omicsonline.org/open-access/the-impact-of-capital-structure-on-financial-performance-of-the-firmsevidence-2167--0234-1000173.php?aid=69978
Rajan, R. G., & Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. The Journal of Finance, 50 (5), 1421-1460.
Salim, M., & Yadav, R. (2012). Capital structure and firm performance: Evidence from Malaysian listed companies. Procedia: Social and Behavioral Sciences, 65 (3), 156-166.
