Economic analysis of financial structure

Economic analysis of financial structure
What is the financial structure?
Financial structure refers to the mix of debt and equity that a company uses to finance its operations. This configuration directly affects the risks and value of the associated business. The company’s financial managers are responsible for determining the best combination of debt and equity to optimize the financial structure.
In general, the financial structure of a company can also be referred to as the capital structure. In some cases, evaluating the financial structure may also include the decision between running a private or public company and the capital opportunities that come with each.
Understanding the financial structure
Companies have many options when it comes to setting up the commercial structure of their business. Corporations can be either private or public. In each case, the framework for managing the capital structure is essentially the same but the financing options differ greatly.
Debt principal is received from credit investors and repaid over time with some form of interest. Equity capital is raised from shareholders who give them ownership in the business of their investment and a return on equity that can come in the form of market value gains or distributions. Every business has a different mix of debt and equity depending on its needs, expenses, and investor demand.
Private vs Public

Private and public companies have the same framework for developing their structure but there are many differences that distinguish the two. Both types of companies can issue shares. Private equity is created and offered using the same concepts as public equity but private equity is only available to select investors rather than the public market on a stock exchange. As such, the process of raising funds from stocks is very different from a formal initial public offering (IPO). Private companies can also go through multiple rounds of equity financing over time which affects their valuation in the market. Companies that mature and choose to issue shares in the public market do so with the support of an investment bank that helps them market the offer in advance and evaluate the initial shares. All shareholders are converted to general shareholders after the IPO, then the market value of the company is evaluated based on the number of outstanding shares multiplied by the market price.

Debt capital follows similar processes in the credit market with private debt being offered primarily only to select investors. In general, public companies closely follow rating agencies with public ratings that help rate debt investments for investors and the market in general. Company debt obligations take precedence over equity for both private and public companies. Although this helps debt come with lower risk, private market firms can still usually expect to pay higher levels of interest because their businesses and cash flows are less well established which increases risk.
Debt vs. Equity
When building a company’s financial structure, financial managers can choose between debt or equity. Investors’ demand for both classes of capital can significantly affect a company’s financial structure. Ultimately, financial management seeks to finance the company at the lowest possible rate, which reduces capital commitments and allows for larger capital investments in the business.

In general, financial managers consider and evaluate the capital structure by seeking to improve the weighted average cost of capital (WACC). WACC is a calculation that derives the average percentage of payments that a company requires to its investors for all of its capital. A simplified determination of the average cost of capital is calculated using a weighted average methodology that combines the payment rates for all of the company’s debt and equity capital.
Metrics for analyzing the financial structure
The main metrics for analyzing financial structure are primarily the same for both private and public companies. Public companies are required to file public filings with the Securities and Exchange Commission that provide transparency to investors in analyzing the financial structure. Typically, private companies report only financial statements to their investors, which makes their financial reports more difficult to analyze.

Data for calculating capital structure metrics usually comes from the balance sheet. The primary metric used in evaluating the financial structure is debt to total capital. This provides quick insight into how much debt is out of the company’s equity and how much is equity. Debt may include all liabilities on the company’s balance sheet or just long-term debt. Equity is found in the equity portion of the balance sheet. Generally, the higher the debt-to-equity ratio, the more debt-reliant the company is.
Debt to equity is also used to determine the capital structure. The higher the debt on the company, the higher this ratio, and vice versa.
Main socket
Financial structure refers to the mix of debt and equity that a company uses to finance its operations. It can also be known as capital structure.
Private and public companies use the same framework to develop their financial structure but there are many differences between the two.
Financial managers use the weighted average cost of capital as the basis for managing the debt and equity mix.
Debt to capital and debt to equity are two key ratios that are used to gain insight into a company’s capital structure.

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