Financial structure refers to the specific mixture of long–term debt and equity that a company uses to finance its operations. The composition directly affects the risk and value of the associated business. The financial manager must decide how much money should be borrowed and the best mixture of debt and equity to obtain, and he must find the least expensive sources of funds for the company.
Like the capital structure, the financial structure is divided into the amount of the company's cash flow that goes to creditors and the amount that goes to shareholders. Each business has a different mixture depending on its needs and expenses. Therefore, each company has its own particular debt-equity ratio. For example, a company could issue bonds and use the proceeds to buy stock, or it could issue stock and use the proceeds to pay its debt.
Financial Structure Versus Capital Structure
While a capital structure and a financial structure both include information regarding long-term financing and common stock, preferred stock and retained earnings, it does not include any information regarding short-term debt obligations. A financial structure does include both long-term and short-term obligations in its calculation. In this regard, the capital structure can be seen as a subset of the financial structure that is more geared toward long-term analysis, while the financial structure provides more reliable information regarding the business's current circumstances.
Differences in Financial Structures
The design of a business's financial structure may vary from country to country and may shift in response to changes within its country’s economy. Often, these differences are attributed to the relevance of the banking system for overall business operations.
Certain production facilities may be more inclined to rely on traditional bank loan offerings, as well as those that have the option to back financing with collateral, such as construction and agriculture. Further, a smaller business may be more likely to consider traditional financing models, as the availability of private investments or the ability to issue securities may not be available.
Businesses in sectors that are more reliant on human capital may be more inclined to finance operations by issuing bonds or other securities. This may allow them to obtain a more favorable rate, since the option to collateralize assets may be highly limited. Larger firms, regardless of their industry, may be more inclined to consider offering bonds or other securities, especially if the businesses already have shares traded on a public exchange.
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