FINANCIAL ACCOUNTING

Financial Accounting

Financial Accounting

Introduction

The capital structure of a company refers to the relative proportion of equity and debts that makes up the financing of a business and presented in the balance sheet. It is an overview of the amount and kinds of capital that a company has employed. It consists of the financing methods it has employed to conduct growth propositions. Examples of this can be research and development or purchase of assets. The more debt a company has employed, the more risk is associated with its operations. An ideal capital structure consists of an appropriate balance of both debts and equity financing.

Discussion

Constitution of capital structure is comprised of various types of debts and equities. Primarily, the elements that form these two asset classes are bonds, preferred stock, and common stock. Bonds are a category of debt, and it included loans that a company takes from financial institutions or investors. Debt is also considered as leverage, and when a company is financed with too much debt on its balance sheet, it can be described as being over-leveraged.

The equity section consists of common stock which is the amount of shares held by common shareholders. The shareholders obtain right to vote for crucial events of company and have an equity stake in the business. Preferred shareholders similarly achieve an equity stake in the business, but are not eligible for voting rights.

A preferred shareholder receives current dividend payments from the net income of company, or profits, as received by common shareholders. Retained earnings are part of reserves and consist of profits that a company does not distribute to shareholders through dividend payments. There are displayed as equity on the balance sheet of company. Additional capital that might be earned is also added to the equity of the company.

The company relies on capital structure regarding the purchase of assets which may generate future economic benefits. Efficient operations of capital structure would require it to generate returns from the equity and debt which need to be higher than the cost of servicing them. Costs associated with servicing debt and equity may include interest and principal payments to bondholders and dividend payments to shareholders.

It is cheaper for companies to issue debts for financing then equity. However debt holders receive fixed ongoing payments associated with the loan, the returns of which might not be as high as those of equity holders. The reason is that shareholders are taking more risk than the debt holders. Hence, the pressure is on the company to constantly increase earnings and the prices of stock for retention of shareholders. In case of insolvency, the holders of bond have a priority over the shareholders.

This concept would be better comprehended if we are to analyze the financing of a company. In this regard, it would be pertinent to look at the case of AT&T plc and Abbott Laboratories.

Equity and Debt financing-A case study

It can be observed from the financial statements of AT&T that the debt maturing within one year amount to ...