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Elements of Capital Structure that require proper analysis and scrutiny
As financial planning and policymaking are of top priority for firms, they must use proper scrutiny and analysis of the following elements of capital structure −
- Capital Mix
- Maturity and Priority
- Terms and Conditions
- Currency
- Financial Innovations
Let's check the importance of each of these important elements of capital structure in detail.
Capital Mix
Firms often need to take a decision on how much debt and equity must be sourced for the operation of the business.
Debt can be acquired from a variety of sources. The firm must realize what is the debt-equity ratio to keep a track of the financial mix that is optimum for it.
The firm should also ascertain whether the dependence on debt is free from excess risk.
A healthy capital mix not only helps the companies reach the financial targets but it also ensures that the day-to-day operations run smoothly.
That is why, the capital mix must be scrutinized in order for a firm to perform better.
Maturity and Priority
The companies that use debt must be aware of the maturity and priority of the debt instruments they own.
Commercial papers have the shortest maturity period, while public debt has the longest.
The company must be able to differentiate between the choices of the maturity periods in order to make the most of the debts it has accumulated.
A company may reach a risk-neutral position by matching the maturity of its assets and liabilities. That is, it may utilize its current liabilities to finance its assets, and medium to long term debts to finance its fixed assets in order of maturities.
Terms and Conditions
It is important for firms to know the terms and conditions attached to their debt financing. The lenders often state the terms when they lend funds and companies can realize various issues of payments from the rules.
The firms can learn about the maturity period, when and how to use funds, and how to pay back the loans it has acquired from lenders.
Terms and conditions are a very important part of capital structuring because, without the knowledge of this, the firm may face sudden hurdles in its operations, as large payments may be due at an unprepared tenure for the firms.
Currency
As overseas marketing offers a possibility of arranging large funds at an attractive interest rate, companies may check whether funding businesses with overseas funds is helpful.
Currency rates often differ from country to country, and it offers an advantage to companies in arranging large funds for operations. Knowing the resources related to currency exchanges is, therefore, a nice idea to inculcate in the capital structure process.
Financial Innovations
Tweaks in the process of financing can also be helpful for companies to arrange funds and deploy them at a lower cost in various projects. For example, using convertible debentures instead of non-convertible ones can be useful in some cases. Companies can use financial innovation to structure capitalization to their advantage in many other ways.
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