Financial Structure


What Is Financial Structure and How Does It Work?

The mix of debt and equity that a company utilises to finance its operations is referred to as financial structure. The risk and value of the connected business are directly affected by this composition. The business’s financial managers are in charge of determining the appropriate debt-to-equity ratio in order to optimise the financial structure.

In general, a company’s financial structure is sometimes referred to as its capital structure. In some circumstances, assessing the financial structure may also include deciding whether to run a private or public company, as well as the financing prospects that each offers.

Financial Structure: An Overview

When it comes to establishing a corporate structure, companies have a number of options. Corporations can be private or public. The basis for managing the capital structure is largely the same in each situation, but the financing possibilities are vastly different.

Public vs. Private

The framework for designing a company’s structure is the same for both private and public firms, but there are a few distinctions. Both sorts of businesses can issue stock. Private equity is formed and offered in the same way as public equity, but instead of a public market on a stock exchange, private equity is only available to a small group of investors. As a result, the equity fundraising process differs significantly from a traditional initial public offering (IPO). Private companies can also go through many rounds of equity funding throughout the course of their existence, affecting their market value. Companies that reach maturity and decide to go public often enlist the aid of an investment bank to help them pre-market the offering and value the initial shares. Following an IPO, all shareholders are converted to public shareholders, and the company’s market capitalization is calculated by multiplying the number of shares outstanding by the current market price.

Debt capital works in a similar way to credit, with private debt being issued to a small group of investors. In general, rating agencies pay more attention to public corporations, with public ratings assisting investors and the market in classifying debt investments. For both private and public companies, debt obligations take precedence over equity. Even if this lowers the risk of debt, private market enterprises should still expect to pay higher interest rates because their businesses and cash flows are less established, increasing risk.

Debt vs. Ownership

Financial managers might select between debt and equity when constructing a company’s financial structure. The demand for both types of money by investors can have a significant impact on a company’s financial structure. In the end, financial management aims to finance the company at the lowest possible rate, lowering its capital requirements and allowing for more capital investment in the organisation.

Overall, financial managers think about and review capital structure in order to reduce the weighted average cost of capital (WACC). WACC is a formula that calculates the average percentage of capital distribution required by a corporation to its investors. A weighted average methodology that incorporates the payout rates of all of the company’s debt and equity capital yields a simplified calculation of WACC.