How To Achieve The Best Capital Structure

According to the accounting identities "assets = Liabilities + owner's equity", the assets of an enterprise have only two sources, one is borrowed one is its own.

That is to say, financing has two ways: debt financing and equity financing.

Enterprises with stable and upward trend of business income will be guaranteed profits, cash flow will be more abundant, and have strong debt repayment capability. Therefore, they can increase the proportion of liabilities without financial risks. Conversely, if the business income rises or falls, the time and amount of cash return will not be stable, and the debt proportion of enterprises should be lower.

Further analysis shows that the scale of enterprise income determines the critical point of debt.

The critical point of debt = operating income * pre tax profit rate / loan interest rate.

If the scale of corporate debt financing exceeds this critical point, it will not only fall into debt repayment difficulties, but also lead to loss or bankruptcy.

Most of the long-term liabilities are fixed assets of enterprises as collateral for loans, so the ratio of fixed assets to long-term liabilities can reveal the degree of safety of enterprises in debt management.

Under normal circumstances, the ratio of fixed assets to long-term liabilities is 2 to 1.

Only those enterprises whose fixed assets are put into normal operation can maintain a ratio of 1 to 1 within a limited period of time.

If the owner of the enterprise does not want to divide the stock of the enterprise into other people, it should use debt financing as far as possible instead of equity financing; on the contrary, if the owner of the enterprise is not too willing to bear financial risk, the debt capital ratio should be reduced as much as possible.

Fourth, according to the degree of competition in the industry.

If the industry is less competitive or monopolistic, the business revenue and profits may grow steadily, and the proportion of liabilities in its capital structure may be higher. On the contrary, if the competition in the industry is strong and the profits of enterprises are decreasing, we should consider reducing liabilities to avoid debt risk.

Fifth, according to the credit rating of enterprises.

The attitude of lending institutions and credit rating agencies is often the deciding factor when debt financing is carried out by enterprises.

Generally speaking, the credit level of an enterprise determines the attitude of creditors. The ratio of liabilities in an enterprise's capital structure should be limited to the credit rating of an enterprise.