Finance

Finance

Capital structure refers to how a company finances its general operations and expansion projection by utilizing various sources of funding. A company could normally have debt capital or equity as a composition of its capital structure (Bierman, H. 2003). Debt capital is usually composed of bonds issued or either, long term notes that are payable by the company whereas equity capital consists of shares (common stock) or retained earnings by the company. Furthermore, equity capital consists of common stock, preference stock and the retained earnings and these make up the total owners equity as recorded in the balance sheet. However, most analysts define the debt part in the capital structure as the long-term liability of the firm (Riahi-Belkaoui, A. 1999). The basic aim of optimizing capital structure is to select that proportion of various forms of debts and equities that maximizes the firm’s value while minimizing the average cost of capital. A firm should always yearn to optimize its capital structure because this will boost its effectiveness in the various operations in the market.

The balance sheet of a company is very key to any investor wishing to put an investment in a particular company and too to the managers in attempting to enhance shareholders wealth. In making this consideration, the health of the balance sheet is the front key to making this decision (Bierman, H. 2003). For instance, in making this evaluation, investors study keenly the working capital adequacy, the asset performance and lastly the capital structure. The fittest capital structure of a company is that which contains more of equity than the debt capital. A company having more of its capital derived from debts is not at all healthy in light of most investor’s analysis. This however is not consistent with the optimal view on capital structure. Ideally there is usually an optimum capital structure that is desirable for all companies. This optimal capital structure is that one that consists of a reasonable optimum amount of debt and also an optimum amount of equity. In practice though, there do not exist a magic ratio of particular leverage that the company can be able to have in its composition (Riahi-Belkaoui, A. 1999). This is also supported by the fact that the debt to equity ratio is different based on the type of industry in which a company is operating, its business type and also importantly the stage in the company’s life cycle.

The table below shows the capital structure of KONE’s business with a comparative analysis of the period 2010 to 2016;

The assets employed in KONE’s business consist mainly of net working capital, fixed assets, and investments which are funded by equity and net debt. KONE aims to maintain a negative net working capital to ensure a healthy cash flow even when the business is growing and to maintain a high return on assets employed (Bierman, H. 2003) . This has greatly impacted on the on KONE’s continued operations in the market. Cash flow from operations is the principal source of KONE’s financing. External funding, as well as cash and financial investments, however, are managed centrally by the KONE Treasury according to the KONE Treasury Policy.

As shown by this extract financial statement of KONE’s business, the company’s total capital composition is on the rise in each year with a slight increase in the percentage ratio of the debt capital as from the year 2012. A key observation is the increase in the working capital each year showing probable expansion of business operation and thus giving a justification to the relatively rising debt capital employed in the business each year. If I were the chief executive officer of this company, I would at this point not change (Bolton, P., Huang, H., & National Bureau of Economic Research,. 2017) much in its capital structure but however insisted on finding a more optimum combination of the components debt and equity to enhance the maximization of the shareholders wealth while also borrowing just what is enough to steer well the daily business operations.

References

Bierman, H. (2003). The Capital Structure Decision. Boston, MA: Springer US.

Riahi-Belkaoui, A. (1999). Capital structure: Determination, evaluation, and accounting. Westport, Conn: Quorum.

Bolton, P., Huang, H., & National Bureau of Economic Research,. (2017). The capital structure of nations.