With considerable experience of working with both public and private companies, helping them to grow and support their businesses, Mark Lyttleton is well aware of the importance of founders choosing the right financial structure for their organisation. This article will explore the issue of financial structure in more detail, looking at how a company finances its operations affects the value and risk of the business.

The financial structure is the mix of equity and debt that a company uses to finance its assets and fund day-to-day operations. The equity and debt that make up a company’s financial structure are a combination of long-term debt, short-term debt, owners’ equity and short-term liabilities.

Every company, irrespective of whether it is private or public, is free to choose its own financial structure. You can learn about the differences between private and public companies by viewing the embedded infographic.

Companies have several choices in terms of structure. The first is whether to be private or public. In each case, the framework for managing capital structure is largely the same, although financing options differ greatly. You can learn about potential funding sources for new start-ups by viewing the embedded PDF.

Equity capital is raised from shareholders, providing them with ownership of a share in the business in return for their investment. In addition to equity and market value gains, shareholders can also receive periodic distributions in the form of dividends.

Debt capital is provided by credit investors, with the company making capital repayments over time along with interest.

The kind of financial composition that a company adopts affects its weighted average cost of capital, or WACC. This, in turn, has a direct bearing on the company’s value. It is therefore incredibly important that a company strives for the optimal financial structure to maximise its value.

A company that is more heavily dependent on debt could potentially have a higher return on investment. However, a financial structure with more debt could put the company at risk if it is unable to honour its financial obligations. A company that is either a monopoly or oligopoly may easily support a structure with more debt, since it can more easily forecast cashflows and sales.

A company operating in a highly competitive market, on the other hand, would not be able to support such a financial mix, since market competition could create volatility in terms of cashflows and earnings, potentially resulting in the company missing its debt obligations and forcing it towards a financial structure with less debt and more equity.

You can learn about the crucial role of a Chief Financial Officer in determining a company’s optimum financial structure by viewing the embedded video.