The company must allocate an ideal weight to the various sources of funding. Any kind of over or underutilization of any source must be avoided. It is important to have a healthy mix of debt and equity in the capital structure.
The company must design its capital structure with the aim of maximum utilization of resources and generating a return higher than the cost of procuring capital. In other words, the Return on invested capital (ROIC) must exceed the Weighted average cost of capital (WACC). The higher the ROIC, the more is the value generated by the company. The efficient management of available resources maximizes the value of the company. In order to improve the efficiency of the capital employed every company must aim at achieving an ideal capital base (Putrajaya Committee on GLC High Performance, n.d.). An optimal capital base helps the company to strengthen its growth prospects by seizing the opportunities. This helps the company in acquiring a competitive position in the market. In designing an optimal capital structure the company has to decide upon a right mix of debt and equity.
Financial ratios help in assessing the financial health of the company (University of Washington, 1998-2000). Ratio analysis is a tool for making a quantitative analysis of the company’s financial performance. It is calculated using the current year figures and then it is compared with the previous years. It also facilitates intercompany comparison between firms belonging to the same industry. The important ratios include debt/equity ratio, current ratio, inventory turnover ratio, asset turnover ratio etc. The current ratio is an important indicator of the firm’s liquidity position. Asset turnover ratio helps in determining the amount of sales generated from the total asset. A high asset turnover ratio indicates that the company is making a good use of its asset structure. But, the ratios of companies belonging to different