Regardless of how vast a business or its area of specialization is, every organization needs a sound capital structure. Capital structure is the particular combination of debt and equity used by a company and denotes how an organization is financing its operations and how effectively it is helping the business accomplish its objectives. It can substantially determine the return a company can generate to maximize its wealth and also alludes to whether or not it sustains the waves of the economic cycle.
A corporate strategy is like the Mate of your ship, the one that directs all your departments and the business exercises towards a common goal. Most often people ask if the capital structure and corporate strategy are intertwined. A well-qualified Corporate Financial services firm can provide you insights on how you can maximize the returns on your investment and design a strategy that empowers you to manage your resources efficiently. But we will identify the link and influence between the above two by understanding what their role is.
What makes a Capital Structure?
The lifeline of any business is its finance and acquiring initial capital is a crucial requirement for the commencement of a business. The ratio of borrowed capital (debt) and owner’s funds (equity) is what the capital structure comprises. A company has to be cautious with any decision to raise funds external sources and optimally allocate them to profitable alternatives. The debt capital is expensive and risky yet accessible, while the equity is reward craving but can be managed without endangering your stability.
- Equity Capital:
Share capital is a source wherein a company offers shares or stocks in the Company against the amount invested by the external parties. Retained earnings are another source of equity capital wherein a company uses retained part of profits kept aside for years to expand or diversify its operations. For some businesses, equity capital is an expensive deal as it involves high flotation costs and takes time to attract subscribers. It is more convenient for established companies to attract investment due to their reputation in the market.
- Debt Capital:
It refers to the amount of capital borrowed from outside sources and has been invested in your business. There are a variety of sources like a loan from commercial banks, financial institutions, issuing debentures, bonds, commercial paper, etc. Debt is risky and costly, but mostly accessible for companies with a higher credit score and financial stability. There are both short-term and long-term instruments available to raise capital, one can choose based on the desired time and ability to repay.
An astute task would be to determine the perfect blend of both debt and equity, after contemplating the pros and cons of each source. This is a significant stage and stands relevant for both small and large-scale businesses. Wise companies consider the cost of capital in comparison with the return on investment and accordingly place debt in their capital structure.
A financial advisory services firm can use its skills and expertise to evaluate your market value, potential growth, and design a suitable structure for your company. In the past many FMCG companies have used long-term debt to raise capital and have still achieved higher revenues with the right strategy.
The decision to raise Debt capital should always be taken considering the risks and rewards associated with the same. A sound capital structure enables management to maximize the earnings of shareholders, ensures appropriate and timely utilization of funds, and increases the market value of the company.
What goes into a Corporate Strategy?
A corporate strategy is an organizational blueprint that outlines the activities to be undertaken for the achievement of its goals, all while minimizing the risks along. It is a fundamental path that assists you in launching the right projects and managing your resources wisely which acts as a foundation for achieving the Company’s strategic goals.
It helps in answering the key aspects of your business like your product portfolio, your organization structure, and design, resource allocation across departments and projects, and the pairing of risk and returns in the right proportion. These are the prime decisions for any business and are known as the “four pillars” of corporate strategy.
- Firstly, in Portfolio Management you decide what products or services you want to develop and offer. A complete SWOT analysis and competitor analysis can help you determine the market response to the product and the growth potential.
- Secondly, an Organizational Design will ensure the right authority, responsibility, and reporting structure is established. Identifying functions, departmentalization, resource allocation, assignment of authority, responsibility, inter-departmental coordination, and extent of the delegation are the main elements of this pillar.
- Thirdly, Resource Allocation, both financial and human is significant to the success of the strategies. Identifying and capturing the right set of skills of an individual and making sure there is a sufficient supply of manpower in the future is important. Ask yourself if you have high-performing assets and whether your investment is gaining returns.
- Strategic trade-offs can be challenging especially when a business chooses to diversify into new areas. It could make you or break you into a disaster; hence an in-depth analysis of a business’s capabilities and endurance will help ascertain the level of risk you are willing to take.
There is a relationship between the resources committed and the strategy chosen. The success of corporate strategy implementation will invariably satisfy the investors and stakeholders of the company. On the contrary, if it fails, the parties will be doomed. Hence, it becomes critical to wisely choose what extent of available resources you should allot to a particular goal or an action plan. It completely depends on the cost of capital to decide whether or not to undertake a project. If there is underutilization of capital, then the right strategic move would be to undertake a joint venture or a merger that would strengthen your base.
An experienced financial advisor would help derive a strategy that exploits your resources to their fullest potential and also help you understand the extent of resources you should commit considering the returns, risk associated, and competitors’ involvement in the industry. There is an influence of strategy and capital structure on each other and apparently, they are interdependent.