Borrowing Brilliance: 11 Factors Affecting Your Capital Structure in 2024

While global markets seem to have found relative calm in 2024, the winds of change still swirl around the Indian business landscape. Rising inflation, tightening regulations, and evolving trade dynamics all pose challenges for business financials in the new year.?

In this environment, one factor remains crucial for navigating uncertainty and charting a course toward sustained growth: your capital structure.

This blog delves into the 11 key pillars that shape your ideal debt-equity balance in 2024. Let’s take a closer look.

Business Size Dynamics and Cashflow

The sheer scale and size of a business play a pivotal role in shaping its capital structure. Small-sized enterprises often grapple with the challenge of raising long-term borrowings, encountering hesitancy from creditors.?

A case in point is the struggle faced by small-scale industries and MSMEs, in securing favorable terms due to its scale.

Similarly, the composition of the capital structure is determined by the business’s ability to create cash flow. It is essential to consider the cash flow in the future to choose the capital structure. The company must have sufficient funds for funding business operations, investing in fixed assets, and fulfilling debt obligations, such as interest and capital repayments.

2. Earnings Stability:

Companies with a track record of stable revenues can comfortably accommodate a larger proportion of debt in their capital structure. In short, Consistent Revenues Fuel Debt Leverage without compromising the capital structure.?

In the Indian context, FMCG giants like Hindustan Unilever have leveraged their consistent earnings to incorporate debt strategically. The company’s total debt in the recent last quarter of Mar 2023 was ?12.72 billion.

Source:?

On the flip side, industries with revenue volatility, such as the consumer goods sector, often rely more on equity financing to weather uncertainties.

3. Competitive Landscape Influence:

The level of competition in a business environment is a crucial factor influencing the capital structure. Industries facing intense competition, like the telecommunications sector, with players such as Bharti Airtel and Reliance Jio, tend to opt for a higher proportion of equity.?

With Reliance Jio and Bharti Airtel holding a combined revenue market share of 78%,? the equity shields them from the earnings volatility associated with high competition.

4. Life Cycle Stage Considerations:

The life cycle stage of a business dictates its susceptibility to failure. In the early stages, companies like Flipkart, during its initial years, leaned more towards equity financing to mitigate the inherent risks.?

As businesses mature, a gradual shift towards a balanced mix of debt and equity is witnessed, reflecting a more stable growth trajectory.

5.? Management Risk Aptitude:

The risk appetite of a company's management is a pivotal determinant in the debt-equity balance. Risk-averse management tends to opt for equity financing, safeguarding against financial turmoil.?

In contrast, entities with a more aggressive risk appetite, akin to infrastructure giants like Larsen & Toubro, often embrace a higher proportion of long-term debt instruments. Here’s an overview of the same:?

Source:?

6. Control Dynamics:

The question of control emerges as a critical consideration in capital structure decisions. Companies desiring autonomy and resisting external interference may veer towards debt instruments. Conversely, those willing to dilute control opt for equity financing.?

7. State of Capital Market:

The preferences of investors and creditors play a pivotal role in shaping a company's financing choices, whether through debt or equity. Occasionally, even when a company aims to issue ordinary shares, it might face challenges attracting investment due to the perceived high-risk nature of its business. In such instances, management can strategically turn to the debt markets to secure funds, showcasing the versatility and attractiveness of debt financing as a viable and dependable alternative.

8. Taxation Policy Implications:

Government taxation policies play a pivotal role in shaping the capital structure landscape. The tax implications associated with debt and equity instruments influence companies' financing choices. The evolving tax landscape in India, with dynamic changes in rates and deductions, prompts companies to reassess their capital structures to optimize tax efficiency.

9. Cost of Capital Considerations:

The cost of raising funds, contingent on the expected rate of return for suppliers, is a critical factor guiding capital structure decisions. While ordinary shareholders face maximum risk, as highlighted by the recent dynamics in many companies, debt instruments such as debentures and bonds attract investors seeking more stable returns.

In this landscape of financial choices, you can consider Aspero with a wide array of exclusive debt instruments with predictable returns up to 14%, which becomes essential for prudent investors.

10. Debt Service Coverage Ratio (DSCR):

Under this, the amount of money needed to pay off debt and the capital for preferred shares is compared to the profit generated by operations. A higher DSCR indicates a better capacity to meet cash obligations, which implies that the company can choose more debt. However, in the case of a lower DSCR, the company prefers more equity.

11. Tax Rate:

High tax rates reduce the cost of debt because interest paid to debt security holders is deducted from income before calculating tax, whereas businesses must pay tax on dividends paid to shareholders. So, a high tax rate implies a preference for debt, whereas a low tax rate implies a preference for equity in the capital structure.

For instance, Reliance Industries, despite a corporate tax rate of over 30%, strategically utilizes debt for acquisitions and expansion projects. (source: Economic Times).

Closing Thoughts

As winds of economic uncertainty swirl around us, one thing becomes clear: your capital structure is your anchor, holding you steady against the tide.?

Embrace debt wisely, prioritizing financial stability over aggressive growth. Let your risk appetite guide the balance, and always consider the cost of capital and market conditions before setting sail. One factor to keep in mind is that debt can grant you control, autonomy, and the freedom to steer your own course.

At Yubi Credit Market, we're your debt navigation experts. We understand the Indian business landscape and the power of strategic debt financing. Our platform offers a wealth of debt financing options, all tailored to your unique needs. Explore Yubi Credit Market and allow us to be part of your thriving business.