Optimizing Capital Structure

When a firm optimizes its capital structure, it redistributes some of the capital either to pay off the company debts or to make new investments for the expansion of the company. The reasons that a company optimizes its capital structure is the same for individuals who manage their finances in order to minimize their debts and have a ore stable capital source.

Companies optimize their capital structure by getting financing sources with the least cost of capital. The optimization of a company's capital structure will affect how the company performs in the market. How the company distributes its capital is the composition of the capital structure. To compute for the total capital, the funds that are available for the company are added and the expenses and debts of the company are then subtracted.

The debts and the equities of the company also affect its capital structure. The amount of money that the company owes from banks, financial institutions and other creditors account for the debts in the capital structure. The equities are the share premiums, share capitals, surplus profits and free reserves of the company. The equities will give the company its leverage in the market. The proportion in the capital structure of each company may vary depending on the type of industry the company belongs to and the market in which the company operates.

To optimize the company's capital structure, it has to determine the right proportion of debts and equities that would increase the value of the company while decreasing the average cost of capital.