How to Determine Your Capital Structure
Determining your corporation’s capital structure is done by calculating the percentage of the total funding that each component represents. By analyzing a corporation’s financial statements, we are able to compile a list of all the capital components on the books. Taking into account all capital components that contribute to the overall capital structure, we are able to calculate the percentage of the total capitalization represented by each capital component. And digging deeper, we will uncover the corporation’s leverage which is described by the ratio of debt financing to equity financing.
Understanding a corporation’s capital structure is necessary to determine which of the many available options is the most fiscally responsible to pursue. Financing with equity versus debt has different capital costs and, as such, will have significantly different long-term effects on the health of a corporation’s finances.
The steps to determining your Capital Structure are as follows:
- Identify all of the corporation’s capital components by examining the most recent financial statements. Compile a list of all debt and equity, including retained earnings, common shares, debt financing and contributions.
- Calculate the sum total of all debt and equity you have identified. This figure should equal the sum total of all the corporation’s assets.
- Take each component of the corporate structure and divide it by the sum total of all components, as calculated in step 2. These calculated figures represent what each source of capital’s percentage is relative to the sum total of the corporate structure.
- These percentages, if calculated on a regular base, can be used to monitor what mix of debt versus equity a corporation currently holds on its books.
Debt financing is the most costly source of capital versus equity. By monitoring a corporate structure over time and incorporating mezzanine debt into the structure, an effective and fiscally responsible capital structure can be planned and achieved.