Thursday 8 November 2018

Why Capital Structure Analysis Necessary?

Analysis of capital structure is regular evaluation of all components in the company's capital structure. The specify Component is major component of the company's equity and debt financing.

Why capital structure analysis needs to be done?

The purpose of the capital structure analysis is to evaluate the combination of equity and debt of the company.

We know that a debt is what's more long term debt are numbering has big risks that could endanger the survival of the company.

  • Uncontrolled Debt could cause a company bankruptcy.

  • The ends of the company could be head for bankruptcy.

  • And not just that alone. Capital structure can also affect a company's stock price.

  • Any changes that occur in the capital structure can get the response varied by investors.

  • Anyone responding to negative and also respond positively.

  • For that is the capital structure of the company need to be analyze.

  • So the optimal capital structure of the company could not even the full risk.

  • The intent of optimal capital structure is the capital structure that gives the best effect for the company. Capital structure that increases the value of the company.

When the analysis of the structure of capital require?

Generally, capital structure analysis was trigger due to events such as the following:

  • The need funds to purchase fix assets

  • Need funds for the acquisition

  • A stable financial condition and existing debt may need to be replace or paid off

  • The existence of a demand for greater dividend distribution

  • Request key investor or the majority shareholder who wants to buy back the shares own by other investors

  • The interest rate has change drastically.

Approach to The Analysis of Capital Structure

The analysis of capital structure can be carry out with at least 3 different approaches.

  • Corporate cash flow Analysis

  • Calculation & analysis of The EBIT-EPS

  • Analysis of the ratio of debt (leverage)

#1. Analysis of Corporate Cash Flow

Good or not, risky or not capital structure of the company can be analyze through his company's cash flow.

  • Cash flow analysis method is simple but the benefits are enormous.

  • Basically, this method wants to ensure that the conditions of the company's cash flow has the ability to pay the burden of capital structure.

Capital structure load means the load arising out of funding of the capital structure of the company. For example:

  • Debt: his load is the principal and interest on debt

  • Stock: his load can be dividend

  • Cash flow analysis use to determine whether the burden face by the company is not too high.

  • The company's cash flow in its inability to pay the burden of capital structure can result in the occurrence of "financial insolvency"

  • Gordon Donald son of Harvard University suggest the company's cash flow must be design to facing the burden of capital structure in the worst conditions though.

#2. Analysis of The EBIT-EPS

  • This analysis is use to see the influence of capital structure towards the EPS at varied levels of EBIT.

  • EPS (earning per share) Profit: sheet shares. (net profits divide the number of outstanding shares)

  • EBIT (earnings before interest and tax): profit (operations + non-operating) before payment of interest expenses and taxes.

  • As it known that capital structure is the percentage of the company's debt and equity.

  • And the company's debt capital structure weights result in the form of interest.

  • The amount of EPS is very influence by the EBIT of the resulting company.

  • And flowers can reduce EBIT result in depletion of EPS.

  • When the resulting EPS of EBIT is too small, the company suggest it could reduce the percentage of debt in the funding issue by adding new shares or the profit from being held.

  • When the resulting EPS still great, the company was able to increase their funding of the debt.

#3. Debt Ratio Analysis

The debt ratio analysis is probably the most commonly use analysis to determine the capital structure of the company. Debt ratio analysis aims to find out whether the percentage of debt own company does not harm the company itself.

At least 4 of imaginary way in analyzing debt base on a ratio-the ratio of the company.

  • Long term debt to equity ratio (LDER)

  • Long term debt to assets ratio (LDAR)

  • Debt to equity ratio (DER)

  • Debt to assets ratio (DAR)

Long Term Debt to Equity Ratio (LDER)

Long term debt to equity ratio (LDER) is a ratio that measures the percentage of long-term debt compare with the number of private equity-own companies. The goal is to measure the LDER capital company that made security against long-term debt. So long term debt will be compare with the total equity of the company.

How to calculate LDER:
LDER = long-term debt/total get started

Long Term Debt to Assets Ratio (LDAR)

Long term debt to assets ratio comparing long-term debt with all the assets own by the company.

This ratio gives an overview how big the number of company assets which are finance by long-term debt.

How to calculate LDAR:
LDAR = long-term debt/total assets

The Debt to Equity Ratio (DER)

Debt to equity ratio is how big a comparison between the total debt (long-term debt + short-term debt) against the capital own by the company.

This ratio gives you an idea how big the assurance that own the company against its creditors.

This ratio can be a reference for investors to invest in the company.

Every investor always takes into account risk.

Generally, the larger the debt ratio so the company is increasingly at risk.

How to calculate DER:
DER = total debt/total equity

Debt to Assets Ratio (DAR)

Debt to assets ratio (DAR) is the ratio of a comparison between the total debt (long-term debt + short-term debt) with total assets own by the company.

This ratio reflects how much the amount of assets purchase or finance using debt. Good debt is short-term or long-term debt.

How to calculate DAR:
DAR = total debt/total assets

In General, debt ratio Method illustrates that the larger the debt own by the company will make the company the higher risk.

  • Debt like the proverbial "two swords".

  • One side has a high risk.

  • Debt can be use as leverage for other companies.

  • With debt, the company can grow quickly.

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