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Corporate financial management
Corporate finance
IMAGE SOURCE
Much has been written
about the abundance of
cash sitting on corporate
balance sheets in recent years.
But as the global economy
continues to recover, the
pressure on corporates to
maintain precautionary
liquidity is decreasing. )n fact,
with activist shareholders
demanding that accumulated
cash be put to use, the new
challenge for treasurers is
to ensure that the companyǯs
capital structure ensures
suicient lexibility for
current ȋand expected futureȌ
economic conditions – rather
than focusing on those
experienced during previous
inancial crises.
Against this backdrop,
now is an opportune time to
reconsider what the optimal
capital structure should be.
Finding the right balance
between cash, debt and
equity funding is both an
art and a science, since an
optimal capital structure is
a dynamic concept that shifts
as the economic environment
changes. Moreover, it is
unique to each company
– optimal means diferent
things to diferent issuers,
varying in line with speciic
operational or strategic
contexts, as well as industry
sector characteristics and
management objectives.
As such, while textbooks
might, from the outset,
suggest deining a companyǯs
optimal capital structure in
terms of the lowest weighted
average cost of capital, it is
actually far more practical
FOR ANY COMPANY, THE OPTIMAL CAPITAL STRUCTURE IS A MOVING TARGET,
SO REGULAR REVIEWS OF THE CAPITAL STRUCTURE ARE VITAL TO ENSURE THAT
BUSINESSES ARE ABLE TO EFFICIENTLY DEPLOY THEIR STRATEGY AND GROW
SUSTAINABLY, AS CHRISTIAN LEIBL AND YURI POLYAKOV EXPLAIN
Optimal capital
structures
It is worth taking the time to consider
what needs to be optimised in the
company’s existing capital structure,
and what is sustainable about it
to start by asking a simple
question around objectives:
what is it that you want to
solve? Being realistic and
open in answering this
question – regardless of
whether the company is
looking to reduce its cost
of capital or simply to
maintain a conservative
inancial proile – is the
only way to achieve a capital
structure that is it for
purpose at that time.
With the objectives
identiied, it is worth taking
the time to carefully consider
what needs to be optimised
in the companyǯs existing
capital structure, and what
is sustainable about it. During
this process, it can be useful
to keep in mind some guiding
principles around what an
optimal capital structure
should deliver:
Optimal capital structure:
guiding principles
͝. Eiciency.
Debt is always
cheaper than equity and
the capital structure should
therefore include as much
debt as the company is
willing to aford, based
on future cash lows. )t is
important to recognise here
that afordability may be
limited by industry sector.
Companies in industries
with stable cash lows,
where the predictability
of their cash generation is
high, will inevitably be able
to aford more than those
in volatile industry sectors.
͞. Flexibility.
When
thinking about the optimal
IAFEI Quarterly | Issue 31 | 68