Which financial structure is best for you and your business? Knowing how to manage or grow your business through careful balancing of debt vs equity can be overwhelming. This where Collins Mann can assist.
Our highly skilled financial advisors can help you structure your finances to ensure they are working hard for your business.
In this article we will cover:
- What is meant by financial structure?
- Factors that affect financial structures.
- Where does capital structure fit in?
- Things to consider.
- Where to seek help.
Definition of Financial Structure
According to Investopedia, in simple terms, financial structure is defined as:
“The mix of debt and equity that a company uses to finance its operations.”
Financial structure is made up of both short- and long-term debts, short-term liabilities such as wages or lease payments and the owner’s equity in the business. All businesses will have a different balance of debt vs equity depending on their expenses, needs and investor input.
Debt refers to and includes any loans or borrowed funds that are accruing interest and are being repaid in instalments.
Equity refers to an owner’s stake in a company and can be used to sell to investors to raise funds for the business.
The financial structure of a company can be ascertained and managed via a balance sheet that shows both the liabilities and equity in a business. This balance sheet is an integral part of financial planning for all Australian business structures.
Why Is Financial Structure Important?
Financial structure is important as it determines the overall value of your business. The structure you choose impacts the weighted average cost of capital (WACC) of your company.
The WACC is determined through a specific formula and shows your percentage of debt vs capital raised. While you can choose the financial structure of your company, both public or private, it is important to pay attention to the balance of debt and equity.
The long-term survival for any company is reliant on being able to meet its financial obligations and maintain adequate cash flow. It will also play into whether you have capital to pursue an investment structure to grow your company’s wealth.
For some types of business structures, financial structure in younger companies or sole trading businesses may not be as critical as older, more established ones, though it should always form part of your business plan structure.
However, the right balance of debt vs equity will still decide whether you are on the path to success or failure. It will also play into whether or not you can secure finance to scale your business in future.
Factors That Affect Financial Structure
Cost of Capital
The cost of capital or the cost of sourcing funds to grow or run your business needs to be addressed. As strange as it may sound, sourcing funds via a loan vs via equity can in fact work out cheaper due to debts not being taxable.
On the other hand, selling a share in your equity to raise funds would be taxable as this is counted as income. In fact, in many company structures, debts are a tax deduction.
Additionally, should the borrowed funds create a return on investment, you directly benefit from this. Should you have sold equity to invest, the new shareholder will also obtain benefit from the return on investment, diluting your return.
Debt can be both positive and negative. A financial structure that uses debt to create opportunities and return profit ratios is ideal. Conversely, debt that costs more than it makes can create more risk and add to issues with insolvency.
Size and Reputation of The Company
If you are an established company with a great reputation, you are more likely to have success in securing capital via debt. Should you be a young business or have a bad credit history, minimal assets or poor cash flow, you will likely need to sell off equity and dilute your ownership to secure finance.
Balancing on a knife-edge is never a good idea! Circumstances in a business can rapidly change and you need to be able to reconfigure your financial structure to accommodate this.
Where Does Capital Structure Fit in?
Many people confuse capital structure and financial structure, and while they have some similarities, they are not the same thing. Capital finance makes up a portion of financial structures as it focuses on long-term aspects of financing a business such as equity or bonds. It does not account for staff salaries, business expenses or day to day running costs.
Overall, the right financial structure for your business is made up of many parts. The decision about whether to lean into debt or equity financing as a component of your financial structure is one that will need ongoing deliberation. Ideally, it should also involve expert advice and guidance.
The key thing to take away from financial structuring however, is that debt doesn’t have to mean negative repercussions in relation to business. With the right structuring, it can actually become a positive way to grow your business and revenue.
Collins Mann Can Help With Your Financial Structure
If you feel that your business’ financial structures are not working well, contact the expert financial planners and advisors at Collins Mann. We can help you propel your business forward, enhancing profitability and value.
We will walk you through the types of business structures best suited to your circumstances and help you develop the right balance.
Our qualified and experienced financial advisors understand the legal structure of businesses and the markets they operate in, allowing us to offer key insights and proven strategies for your company structure.
Let us handle the details and devise the optimal financial structure for your business, call Collins Mann today on 07 3251 3200.