Comparative Analysis of Capital Structure of SMES at NSIC

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Comparative Analysis of Capital Structure of SMES at NSIC (Final Project Report)

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INTRODUCTION 

The financing decisions occupy a pivotal role in the overall finance function in a corporate firm which mainly concerns itself with an efficient utilization of the funds provided by the owners or obtained from external sources together with those retained or ploughed back out of surplus or undistributed profits. These decisions are mainly in the nature of planning capital structure, working capital and mechanism through which funds can be raised from the capital market whenever required. The financing decisions  explains how to plan an appropriate mix with least count, how to raise long term funds, and how to mobilize the funds for working capital within a short span of  time. Such a financing policy provides an appropriate backdrop for formulating effective policies for investment of funds as well as management of earnings. It contributes to magnifying the earnings on equity as profitability (expressed as return on equity), to a large extent, is dependent on the degree of leverage in the capital structure. Besides, the valuation of the structure of physical assets depends fundamentally on the financing mix. This makes it necessary for the management of a firm to pursue a well thought out of financing policy, which ought to be framed initially, incorporating, among other things, the proportion of the debt and equity, types of debts and own funds to be used and volume of the funds to be raised from each source or combination of sources, to enable the firm to have a proper capitalization. In the absence of this, the firm may face the problem of either over-capitalization or under-capitalization impeding its smooth financial functioning.

It is obvious that functioning decisions are extremely important for corporate firms. Such decisions, in management parlance, are termed as capital structure decisions. The term capital structure is used to describe the combination of various sources of finance employed to raise funds. It implies, in other words, that when a firm chooses to use a group of sources in certain proportions the resulting pattern is referred to as capital structure of the firm. The sources of finance could be divided in terms of ownership of funds and duration of funds. The former comprises owned and borrowed funds while the latter includes long, medium and short term funds. Of the two, the duration-based classification is useful for preparing a plan to meet long term as well as short term capital requirements while ownership-based classification is useful for selection of specified sources, determining debt-equity ratio and analyzing impact of capital structure decisions on the earnings on equity. As the ownership based classification suggests that there are two types of sources of finance, namely owned and borrowed funds, the capital structure represents the component relationship between owned and borrowed funds.  The owned funds which are also described as equity fund may be defined as funds provided by or belonging to the share-holders. In the opinion Raj want Singh and Brij Kumar, the capital structure is made up of the long term borrowings, the preferred stock and the common stock equity including all related net worth accounts. Similarly Morarka.R observes that the capital structure implies a degree of permanency and normally omits short term borrowings of less than one year but would include other intermediate and long term borrowings. The financial institutions consider only long term sources of finance for computing the debt-equity ratio of corporate firm.

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