Capital structure analysis is a process that involves evaluating the combination of different debt and equity holdings that are currently in the possession of a company. The purpose for the analysis is to determine if the current mix is providing the greatest level of benefit for the company, or if there is a need to make some changes to the capital structure that would result in a more sound financial position. In order to engage in a capital structure analysis, it is important to identify all types of debt and equity currently held, project the impact of the current combination on the business operation, and then determine what if any changes should be made in order to strengthen the company’s position within a defined period of time.
One of the first steps in any capital structure analysis is to identify the debt and equity that is currently held by the company. For purposes of the analysis, the debt will include all short-term and long-term obligations, such as loans, bond issues, and any type of outstanding payables. Typically, the company’s need for working capital will also be classed as part of the debt currently held, with this type of obligation classed as part of the short-term debt.
After identifying all debt currently held by the company, the next move will focus on determining the equity holdings that currently apply to the business. This will include any retained earnings that the company currently holds, as well as any preferred stock and even common stock. The idea is to be in a position to consider the amount and the type of debt held against the amount and type of equity holdings the company currently carries. With this data in hand, it is easy to calculate the debt to equity ratio of the company, which in turn provides a quick snapshot of the financial stability of the business operation.
While capital structure analysis is about understanding where the company is today in terms of stability, company owners can also use the data collected to determine if some changes in the current structure of finances would enhance the company operation in the future. This often involves considering the movement of the economy in general, as well as emerging trends within the market or markets that the company is connected with. Doing so can lead to a reorganization of debt using some of the assets of the business, a move that may be prudent if there is anticipation of a downturn in the economy.
Potential investors will also be interested in the results of the capital structure analysis, since those results can make it easier to decide whether to hold, sell or acquire more shares of the company stock. By comparing the analysis results with those from prior periods, it is possible to spot positive or negative trends that are emerging, then decide if the business is likely to continue profitability in the future. From this perspective, conducing the capital structure analysis can aid owners in making changes that strengthen the business while also allowing investors to determine to what extent they wish to be involved with that company.