Introduction
The ratio of debt to equity that a business uses to fund its operations and capital expenditures is known as its capital structure. It is a crucial decision for any business, as the wrong capital structure can seriously affect its financial health and ability to grow. Several factors can influence how a company builds its capital structure, such as the company’s stage of growth, the industry it operates in, its cash flow, and its risk profile.
Discussion
A company in its early stages of growth might prefer to rely on equity financing to fund its expansion, as it may need more assets to offer as collateral for loans. On the other hand, a mature company might use more debt financing, as it has a track record of generating cash flows that can be used to service its debt (Hirdinis, 2019). Additionally, a company’s risk profile is also an important consideration when building its capital structure. A company with stable cash flows and low business risk might opt for a higher proportion of debt, as it can benefit from the tax shield that interest payments provide.
Further, a large corporation such as Microsoft might have access to more diverse financing options, such as issuing bonds or commercial paper, which are only available to some companies. In contrast, a small manufacturing company with few employees may need to rely more on equity financing, as it may need more assets to pledge as collateral for loans (Hirdinis, 2019). In comparing the capital structures of Microsoft and a small manufacturing company, one might find that Microsoft relies more on debt financing due to its lower cost of capital and scale, while the small manufacturing company relies more on equity financing due to its higher risk profile and limited assets. Moreover, in deciding what classes of stock to issue, a company should consider several factors, such as the preferences of its current investors, expected demand for its stock, and growth prospects.
Conclusion
In conclusion, building a capital structure is a critical decision for any company. The factors that influence this decision are numerous, and their relative importance depends on the specific circumstances of each company. Therefore, it is important for a company’s capital structure not to be a fixed decision. Ultimately, a company should aim to find a capital structure that balances its need for financing with its ability to service its debt and grow its business.
Reference
Hirdinis, M. (2019). Capital structure and firm size on firm value moderated by profitability. Web.