The financial structure It is the combination of short-term liabilities, short-term debt, long-term debt, and capital that a company uses to finance its assets and operations. The composition of the financial structure directly affects the risk and value of the associated business.
The financial manager must decide how much money to borrow, obtain the best mix of debt and equity, and find less expensive sources of funds. As with the capital structure, the financial structure divides the amount of the company's cash flow allocated to creditors and the amount allocated to shareholders..
Each company has a different combination, according to their expenses and needs; therefore, each business has its own particular debt-to-equity ratio. It may be the case that an organization issues bonds to use the income obtained to buy shares or, conversely, that issues shares and use these profits to pay its debt.
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Financial structure refers to the art of designing the mix of funds that will be used to finance a business, especially with regard to the amount of debt to be raised and with what repayment profile..
Includes analysis and decisions regarding debt instruments, when more than one is available.
Relying significantly on funds for debt allows shareholders to obtain a higher return on investment, as there is less capital in the business. However, this financial structure can be risky, as the company has a large debt that must be paid..
A company positioned as an oligopoly or monopoly is better able to support a leveraged financial structure, since its sales, profits, and cash flow can be reliably predicted..
Conversely, a company positioned in a highly competitive market cannot withstand a high degree of leverage as it experiences volatile profits and cash flows that could cause it to miss debt payments and trigger bankruptcy..
A company in the latter position needs to take its financial structure to the direction of more capital, for which there is no repayment requirement.
A financial structure includes long and short-term obligations in its calculation. In this sense, the capital structure can be seen as a subset of the financial structure, being more oriented to long-term analysis..
The financial structure reflects the status of working capital and cash flow, wages payable, accounts payable, and taxes payable. Therefore, it provides more reliable information regarding current business circumstances..
Leverage can be positive or negative. A modest increase in earnings before tax will give a large increase to earnings per share, but at the same time increase financial risk..
The financial structure should focus on lowering the cost of capital. Debt and preferred equity capital are cheaper sources of financing compared to equity capital.
It should be considered in the financial structure that the risk of loss or dilution of the control of the company is low.
No company can survive if it has a rigid financial composition. Therefore, the financial structure must be such that when the business environment changes, the structure must also be adjusted to cope with expected or unexpected changes..
The financial structure must be formed in such a way that there is no risk of an insolvency of the company.
The financial structure describes the origin of all the funds that a company uses to acquire assets and pay expenses. There are only two types of sources for all those funds.
Companies acquire funds through debt financing, mainly from bank loans and the sale of bonds. These appear on the balance sheet as long-term liabilities.
It should be noted especially that the company's debt (balance sheet liabilities) also includes short-term obligations, such as accounts payable, short-term promissory notes, wages payable, and taxes payable..
These are those that the company owns in its entirety, appearing on the balance sheet as “shareholders' shares”. In turn, the actions come from two sources:
- Paid-in capital: are payments that the company receives for the shares that investors buy directly from the company when it issues shares.
- Retained earnings: these are the after-tax earnings that the company maintains after paying dividends to shareholders.
These two sources taken together are a complete side of the balance sheet. Entrepreneurs interested in the financial structure of the company will compare the percentages of each source with respect to the total financing.
The relative interest rates will define the financial leverage of the company. These determine how owners and creditors share the risks and rewards given by the performance of the business..
A small business is more likely to consider traditional financing models. The possibility of receiving private investments or issuing securities may not be available to you.
Companies in sectors that rely more on human capital may prefer to finance their operations by issuing bonds or other securities. This may allow them to obtain a more favorable rate, as the option to guarantee with assets may be very limited..
Larger companies, regardless of their industry, are more inclined to consider offering bonds or other securities, especially when companies already have shares traded on a public market..
The following image shows how financial and capital structures appear on a company's balance sheet.
The groups of balance sheet items define three structures for the company: the asset structure, the financial structure and the capital structure..
The financial structure of the company is shown on the entire equity and liabilities side, and the capital structure is a section of the financial structure.
The financial and capital structures show how the investor owners share the risks and rewards of the company's performance. As a result, these structures describe the leverage.
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