Capital structure of an entity is determined through the ratio of its debt and equity. Managing capital structure in an entity is pivotal to calculate its cost of capital for potential buyers of shares and providers of finance. Debt driven company will have higher cost of capital as compared to the company managing an optimal capital structure.
Optimal capital structure is premised on a suitable blend of equity and debt financing that maximizes shareholders wealth/business value and minimizes cost of capital. Setting an optimal capital structure is vital for a business as it require to generate funds from various sources including shares, preference shares, bonds, debentures, sukuk, leases, loans and other types of finances offered by financial institutions. Entrepreneurs will be able to generate funds for their businesses at lower financing cost if they have optimal structure of its capital, that ultimately determines long term business stability.
- Investment appraisals,
- Product launching,
- Initial Public Offering (IPOs),
- Project evaluation,
- Business/share valuation,
- Cash flow management,
- Drafting prospective financial information
- Liquidity and business solvency analysis; and
- Any remnant purpose that entrepreneurs deem fit in their particular business scenario.
On the other hand, Budgeting is normally for one or two fiscal years, based on existing records and future cash flows that business is expected to generate or maintain. Typically, budgeting is used for:
- Variance analysis of actual records vis-à-vis budgets.
- Cost containment to fit-in budgeted figures.
- Monitor project cost overrun.
- Plan future operations and set realistic targets suitable within budgeted limits.
- Highlighting cash excess/shortage and consequential fund management.
- Monitor overall business performance and act as a yardstick for business decisions.
Maintaining an optimal capital structure is based on below key parameters:
- Effective cash flow management by preventing over or undercapitalization.
- Effective working capital management, to avoid fund blockage in inventory and receivable & payable cycles.
- Instilling confidence of equity finance provider which have lower cost of capital than debt finance provider.
- Suitable business structure, that requires least funds to finance business operations.
How our CFOs stand out as Optimal Capital Structure Advisors
Being Chartered Accountants, we possess technical knowledge about how an organisation's Weighted Average Cost of Capital (WACC) is derived and how it is used to calculate shareholder's wealth or business worth. Our well-rooted assimilation with each component of WACC, together with our professional experience working with regional large sized conglomerates, serve as an ideal combination to manage and maintain optimal capital structure of our clients.
Our recommendations on optimal WACC are based on analysis of the existing type and ratio of capital structure to prepare report on gap analysis with optimal WACC for our client that could lead to generation of long-term funds at least financing cost.