Presentation done by Melnicova Anastasia
WHAT IS FINANCIAL
STRUCTURE?
What is Financial Structure?
The financial structure of a company refers to the way it finances its operations through a mix of
debt and equity. This structure is crucial because it affects the company's risk profile, cost of
capital, and overall financial stability.
Why It Matters:
A well-structured financial setup can lead to lower costs, improved operational efficiency, and
greater flexibility in capital management. Understanding the components and implications of
financial structure helps stakeholders make informed decisions.
KEY COMPONENTS OF
FINANCIAL STRUCTURE
DEBT FINANCING: EQUITY FINANCING:
This includes loans, bonds, and credit lines This consists of funds raised by issuing shares to
that a company uses to raise capital. Debt investors. Equity financing does not require fixed
comes with fixed obligations, such as interest repayments, but it dilutes ownership among existing
payments, which must be met regardless of shareholders. Common stock and preferred stock are
the company’s cash flow situation. the primary forms of equity financing.
DEBT FINANCING
EXPLAINED
TYPES OF DEBT:
SHORT-TERM DEBT: LONG-TERM DEBT:
Includes obligations that are due within one Refers to obligations that mature in more
year, such as bank loans or lines of credit, than one year, such as corporate bonds
often used for operational expenses and or mortgages. These are often used for
working capital. significant investments, like purchasing
property or equipment.
Characteristics:
Debt financing can provide tax benefits since interest payments are tax-deductible.
However, it also introduces fixed financial obligations that the company must meet.
EQUITY FINANCING
EXPLAINED
TYPES OF EQUITY:
Common Stock: Represents ownership shares in a
company, typically granting voting rights and potential
dividends, though these are not guaranteed.
Preferred Stock: Usually does not offer voting rights
but provides fixed dividends and priority over common
stockholders in case of liquidation.
Characteristics:
Equity financing carries no repayment obligations, which can reduce
financial stress during downturns. However, it dilutes ownership and
may lead to higher overall costs due to investor return expectations.
THE CAPITAL
STRUCTURE FORMULA
Leverage Ratio:
This ratio indicates the extent of a company’s debt compared
to its equity. Higher leverage means higher risk, but also the
potential for higher returns if managed properly.
Optimal Structure:
Finding the right balance between debt and equity is essential EQUATION:
TOTAL CAPITAL = DEBT + EQUITY
for minimizing the overall cost of capital while managing
financial risk.
INFLUENCING
FACTORS
BUSINESS RISK:
Companies with higher operational volatility
typically favor lower debt levels to avoid
financial strain during tough times.
MARKET CONDITIONS: TAX IMPLICATIONS:
Economic factors, such as interest rates and The deductibility of interest payments
market liquidity, can significantly impact the encourages companies to utilize debt. In
availability and cost of both debt and equity contrast, dividend payments from equity
financing. financing do not receive similar tax benefits.
Tax Efficiency: Interest payments can reduce taxable income,
resulting in lower overall tax liabilities.
Ownership Retention: By choosing debt over equity, existing
shareholders maintain a larger percentage of ownership.
Lower Cost: Debt financing typically carries a lower cost than
equity because lenders demand lower returns compared to
equity investors.
BENEFITS OF
DEBT FINANCING
RISKS OF
DEBT
Financial Burden: Companies must meet their debt
FINANCING obligations regardless of revenue fluctuations, which
can lead to financial distress.
Covenants and Restrictions: Lenders may impose
limitations on operational practices, affecting
flexibility.
Bankruptcy Risk: High levels of debt can lead to
insolvency if a company cannot meet its obligations.
Flexible Financing: No mandatory repayments during economic
downturns, providing financial breathing room.
Attracting Expertise: Equity investors can bring valuable insights,
networks, and strategic guidance.
Strengthened Balance Sheet: A solid equity base improves the
company’s leverage in securing additional financing.
BENEFITS OF
EQUITY FINANCING
RISKS OF
EQUITY Ownership Dilution: Issuing new shares reduces
existing shareholders' ownership percentages.
FINANCING Costly in the Long Run: Equity can be more expensive
than debt due to higher expected returns from
investors.
Performance Pressure: Investors typically expect
returns and may influence company decisions and
strategies.
BEST PRACTICES FOR
FINANCIAL STRUCTURING
Regular Assessment: Companies should
periodically review their capital structure to adapt
to changing market conditions and business needs.
Risk Management: Striking a balance between debt
and equity helps optimize financial stability and
growth potential.
Stakeholder Engagement: Involving key
stakeholders in financial decisions can lead to
more informed and strategic choices.
CONCLUSION
A well-structured financial foundation is vital
for a company's sustainability, growth, and
ability to navigate market fluctuations.
Continuous evaluation and adjustment of the
financial structure are essential to align with
dynamic market conditions and strategic
goals.
