Target capital structure is the capital structure that is the most advantageous way for funding a company. There may be a number of optimum capital structures of a company, but the target capital structure is the only one that is considered to be ideal.
Capital structure decisions are usually taken in two levels.
In the first level, the financial managers prefer to identify the resources of the company to build optimum capital structures.
In the second level, the board of directors and the chief financial officer chose a target capital structure for the company from the given options.
Target capital structures are different from optimal capital structures in the sense of their formation too. In general, optimal capital structures consider only the financial aspects of a firm, while the target capital structure considers all stakeholders.
Target capital structure decisions are very sophisticated in the sense that they contain considerations of the firm, the customers, the society, and the government regulation in its formation. It is a holistic view of the formation of capital structures that make target capital structures special and different from the optimum capital structure.
Optimum capital structure and target capital structure are different in their nature too. While optimum capital structure decision is taken by the finance managers to represent the best possible option of capital structuring, target capital structure is the most ideal version of the capital structure formed by top-level executives and business owners.
The aim of creating a target capital structure is to increase the market value of a company to its maximum. In doing so, the board of directors and top-level executives try to ascertain the financial measures that can increase the value of a company’s share. It is notable that optimal capital structure tends to do the same too, but its formation is different from the way of formation of target capital structure.
Target capital structure is formed, keeping the equity shareholders in the focus. As the equity shareholders are the owners of the company, a business must address their needs by maximizing the returns. Target capital structure is difficult to form because it needs accurate estimations and calculations of various complex issues pertaining to it. However, it is one of the most important decisions that must be taken by business firms because it creates room for the overall business environment of a company.