Capital Structure

Financial decision makers need to find answers to key questions, including the following: • Long-term investment (capital budget) the company should make and the impact of investment and financial decisions on company value (evaluation). How to collect cash for the necessary investment. This is called "financing decisions" (capital cost, capital structure and lease). How the company manages daily cash and finance (short term funding and net working capital).

Here, financing is limited to optimal capital structure (debt ratio or leverage). This is the level that minimizes the company's capital cost. This optimal capital structure determines our reserve borrowing capacity (short term and long term) and risk of potential financial difficulties. If the capital cost exceeds the direct competitor and there is no new investment, the company establishes this structure. This is an indicator of the company's business efficiency. Profitability also indicates that management needs to take corrective action in inefficient areas and measures the profit relationships with sales, total assets, and net assets. Companies need to set profitability targets when companies need to operate more efficiently and pursue improvement of value chain activities.

Because capital is expensive for small and medium-sized enterprises, it is particularly important for owners of small businesses to determine the target capital structure of their business. Determining the capital structure is complex and you need to consider a variety of factors. In general, companies that tend to have stable sales levels, assets that provide collateral suitable for loans, and companies with high growth rates can use more debt than others. Companies with conservative management, high profitability, or low credit ratings, on the other hand, may wish to rely on capital.

The capital structure can be a mixture of the company's long-term borrowings, short-term borrowings, common stock and preferred stock. When analyzing the capital structure, our short-term and long-term debt ratios are taken into account. When analysts refer to capital structure, analysts may refer to company D / E ratios that provide insight into the company's risk profile. Companies that raise large amounts of money through debt often have a more aggressive capital structure and therefore pose a greater risk to investors. However, this risk may be the main cause of the company's growth.

The company's capital structure is the composition or "structure" of the liabilities. For example, companies with $ 20 billion capital and $ 80 billion debt are said to be 20% equity finance and 80% debt finance. In this example, the ratio of corporate bonds to the total amount of funds raised (80%) is called company leverage. Indeed, the capital structure can be quite complicated, including dozens of sources of funding. The Modigliani-Miller theorem proposed by Franco Modigliani and Merton Miller in 1958 is often considered purely theoretical as it ignores many important elements in the process of capital structure such as fluctuations, but the company's Uncertainty that may occur during the funding process. According to the theorem, in the perfect market, the company's financing method is irrelevant to its value.