Shares and debts are the two sources of financing that can be accessed on the capital markets. The term “capital structure” refers to the general composition of a company’s financing. Changes in the capital structure can affect the cost of capital, the net result, the leverage ratios and the obligations of listed companies.
The weighted average cost of capital (WACC) measures the total cost of capital to a company. Assuming that the cost of debt is not equal to the cost of equity, the WACC is changed by a change in the capital structure. The costs of equity are generally higher than the costs of debts, so increasing the share financing increases the WACC gewooJoseph K.ijk. Equity financing does not affect profitability, but equity financing can dilute existing shareholders because the net result is distributed over a larger number of shares. When a company raises money through equity financing, there is a positive point in the cash flow from financing activities section and an increase in ordinary share at nominal value on the balance sheet.
If a company raises money through debt financing, there is a positive item in the financing part of the cash flow statement and an increase in liabilities on the balance sheet. The debt financing comprises the principal, which must be repaid to the lenders or bondholders. Although debts do not dilute ownership, interest payments on debts lower the net result and cash flow. This reduction in the net result also represents a tax benefit due to the lower taxable income. Increasing debts cause leverage ratios, such as debt and debt, to rise. Debt financing often comes with covenants, which means that a company must meet certain interest coverage and debt level requirements. In the event of liquidation, debt holders are senior to holders of equity instruments.