A company’s financial structure determines how it finances its assets and operations. Or, to put it another way, it’s the combination of debt and equity that a company employs to fund its assets and run its day-to-day operations. Short-term debt, long-term debt, short-term liabilities, and owners’ equity are the debt and equity that make up the financial structure.
Financial Structure’s Importance
Every business, whether public or private, has the freedom to select its structure. Except for equity, both public and private enterprises have access to the same types of funding sources. A firm, on the other hand, cannot survive with any arbitrary mix of debt and equity.
The WACC (Weighted average cost of capital) of a corporation is affected by the financial composition used. It has a direct impact on the firm’s valuation as a result. If a company wishes to optimise its worth, it should strive for an optimal structure.
The function of the CFO (chief financial officer) is critical in such a business since he or she is responsible for determining the best financial structure for the organisation. To review and analyse a company’s financial structure, a CFO typically performs trend and ratio analysis.
What is the best way to optimise?
When creating a financial composition, a manager or CFO should consider the following factors:
Leverage
A company’s debt might be either positive or negative. Debt can help a corporation increase its return while also providing tax benefits. However, too much debt might cause cash flow problems for a corporation.
Control
The finance manager must guarantee that the financial structure does not lead to a significant loss of control.
Flexibility
In difficult times, a corporation with a strong financial structure may not be able to endure. As a result, the financial structure would be designed in such a way that a corporation could quickly change it as needed.
Solvency
The manager must ensure that there is no risk of solvency when designing or rebuilding a financial composition.
Credibility
A corporation with a bad reputation in the industry may not have many options for obtaining loans. Even the channels that are available would have a higher interest rate. As a result, the corporation may need to raise cash through equity.
Capital Structure vs. Financial
The concepts of finance and capital structure are comparable, but they are not the same. The one substantial distinction between the two has previously been highlighted. It’s also the fact that the capital structure exclusively deals with long-term debts and equities. On the other hand, financial composition comprises both immediate and long-term debt and liabilities.
On this premise, we can conclude that financial composition has a greater impact than capital structure. Or, to put it another way, capital structure is a component of financial structure.
Aside from that, there are a few minor distinctions between the two. The first is that the capital structure includes everything under the shareholders fund and non-current liabilities, whereas the other structure covers practically the entire equity and liability side.