The capitalization structure of the business is its Foundation. From his first sale of the projects it is investing in down the road, it all starts with how it finances its operations. The capitalization structure can have a huge impact on the profitability of the company.
What Is The Capitalization Structure?
The capitalization structure, often called the capital structure simply refers to the money a company uses to Finance operations, or where the money. The capital can be increased either through the acquisition of debt or equity. Equity financing by selling stock to shareholders. Debt can come from many sources such as Bank loans, personal loans and credit card debt, but it must always be repaid at a later date, usually with interest.
The cost of capital
Both funds capital to incur some degree of costs that must be paid for accessing the funds is called the cost of capital. For borrowed capital is the interest rate charged by the lender. The cost of equity is the rate of return on investment that shareholders expect dividends. While debt tends to cost less than equity capital, both types of capital funding impact profit margins of the Company substantially.
Perhaps the most striking example of this is the impact of debt on the bottom line. Somewhere between operating expenses and net profit figure on the profit and loss account of the company the expenses incurred for the payment of debts. Especially a company with a debt-heavy capital structure makes large interest payments each year, thus reducing net profit.
The positive effect of the loan capital
Debt capital can also have a positive impact on profitability. Debt allows companies to use existing tools, providing a more rapid growth than would have been possible. Effective use of debt financing leads to higher income which exceeds expenses for the payment of interest. In addition, interest payments are tax deductible, reducing the company’s overall tax burden.
The influence of capital on the profitability of the company is equally important, though not quite so straightforward. While stock funds growth stimulation, not requiring the repurchase, shareholders receive limited rights of ownership, including the right to vote. They also expect a return on their investment in the form of dividends, which are paid only if the company makes a profit. The business is funded by equity beholden to your investors and must remain profitable in order to fulfil this obligation.
Capital structure and profitability
Knowledge of business overall, so the proverbial pie of the profit should be divided in more parts. The company is fully financed by debt can have hefty interest payments each month, but when all is said and done, the profits belong solely to the owners of the business. Without shareholder’s dividends to pay, profits can be reinvested in the business through buying new equipment or opening new locations, creating even greater profits down the road.
Another indirect effect of capital structure on the profitability of its impact on the potential availability of additional capital, if required in the future. A company with very high debt to equity may be seen as too risky as creditors and potential shareholders, making it difficult to raise additional funds. Limited access to financing capital, in turn, limits the growth potential of the business, while maintaining profitability stagnation.
(For associated reading, see: what is the theory of capital structure?)