Capital structure

The capital structure of a company depicts its long term financial position. It is the foundation upon which the firm's short term financial activities are carried out.

The issue of capital shares and debt is the principal method of raising long term funds from capital markets. Since one of a company's major objectives is to maintain an efficient capital structure, it will want to market those securities which involve
the least costs and risks and provide the greatest tax advantage.

Source

Ordinary shares

(a) Authorised ordinary shares

There is no legal restriction on the size of authorised capital, but a change can only be effected by a resolution of the shareholders. Such a resolution is itself only possible if the articles of association allow such an action. In the absence of a suitable clause in the articles, they must
first be altered by a special resolution of the shareholders. Today, par value shares may or may not be the issuing price. It is rarely the subsequent stock market price. It is well for the financial managers to
bear in mind that investors have shown a marked preference in recent years for shares to carry a low rather than a high par value price.

This preference is reflected in the turnover of shares with market value of under N1.00. When considering a new financial operation, it is worth remembering that low par value permits more shares to be issued for a given total value.

(b) Issued share capital

Issued shares are those for which the company receives subscription of
cash. They form part of the authorised shares. If the shares were issued
at par, the balance sheet figure will equal the total sum received. If the shares were sold at a premium over par value, this premium will be separately listed as capital reserve or surplus.

Ordinary shares have legal participating rights as members of the company, and these rights are stated in the issued prospectus. Ordinary shares are the residual claimants to the assets of their company. They are the beneficiaries of any net balance of profits and other monies which may accrue. The right to share in net profit should not be confused with
the right to receive dividends. The ordinary shareholders unlike the holders of preference and fixed interest stock are entitled to receive dividends only after they have been declared and recorded as current liability. Participation in the net balanace of profit may take the form of
scrip issue or bonus shares. The shareholders interests may best be served
by the company's management reinvesting profits effectively so that share
prices rise.

Ordinary shareholders usually carry the right to vote at meetings. Non voting shares are also issued usually in form of scrip issues.

Preference shares

Preference shares, as the name suggest, have prior claim to profits than
Preference shares ordinary shares. They have first claim of all the shareholders on the residual capital value resulting from liquidation.

Preference shares carry a fixed rate of dividend which may be cummulative. When they are cummulative the obligation is carried forward from year to year until it is discharged. In the case of non
cummulative shares, if the company is unable to discharge the obligation
in any year, the obligation is cancelled for the year. Accumulation of preference dividends must be paid before ordinary shares are paid.

Preference shares can be issued either with a redemption date or as a permanent investment in the firm. A redeemable preference share is more likely to be used when interest rates are high and the dividend required by the investor is higher than the company wishes to pay.

A further class of preference shares can be created by adding a conversion previledge. Convertible preference shares give the holder the right to exchange preference shares for ordinary shares at a future date.

The quantities, timing and rates of exchange are specified in the prospectus when the securities are issued and this schedule is also printed in the share certificate.
When a company issues convertible preference shares, the financial
manager must make due allowance for the eventual dilution of ownership and control implicit in the offer of conversion option.

Ownership and control can be maintained when preference shares are exchanged for ordinary shares by suitable growth in earnings. Financial managers can readily calculate the extra earnings required to counter- balance the expected dilution.

Reserves

(a) Capital reserve - Capital reserve balance originates mainly from the sale of shares whether ordinary or preference at a price above par value. Another source of capital reserve is whenever asset with
substantial hidden appreciation are re-valued. From time to time, whether due to tax or other consideration, companies re-appraise the market value of their assets. In all cases where the new values are greater than the old, the net balance is added to capital reserve.

(b) Revenue reserve- Revenue reserve frequently called retained earnings represent the undistributed profits of the firm. It serves as a major internal source of long term fund. No outsider has any
control on this source of finance.