Accounting – 5.3 Limited companies | e-Consult

The company's capital structure is composed of share capital (ordinary shares) and loan capital (preference shares). The share capital is the money raised by selling the 1000 ordinary shares at £2 each, which totals £2000. The loan capital is the money raised by selling the 200 preference shares at £5 each, which totals £1000. Preference shares represent a debt obligation for the company, as they are entitled to a fixed dividend.

Implications for Financial Risk:

A capital structure with a higher proportion of loan capital (like preference shares in this case) generally increases the company's financial risk. This is because the company has a fixed obligation to pay the dividend on the preference shares, regardless of its profitability. This fixed obligation can strain the company's finances, especially during periods of low profitability.

However, the presence of share capital can mitigate this risk. Shareholders are only entitled to a dividend if the company is profitable, so the company is not obligated to pay dividends to shareholders. Therefore, a mix of share and loan capital can provide a balance between financial risk and access to funding. In this case, the 200 preference shares represent a significant portion of the capital, increasing the financial risk compared to a company with only ordinary shares.