Lesson 34 - Advanced Accounting Course

Lesson 34: Corporate Capital Structure and Debt Management

Understanding how companies finance their operations is key to mastering financial and managerial accounting. This lesson covers:

• What capital structure is
  
  

• The different types of funding sources
  
  

• The pros and cons of debt vs. equity
  
  

• How companies manage debt
  
  

• Accounting and financial statement impacts
  
  

Let’s break it all down step-by-step. 🧩

💡 What is Capital Structure?

Capital Structure is how a company finances its overall operations and growth—using a mix of:

• Debt (like loans or bonds)
  
  

• Equity (like shares issued to investors)
  
  

👉 It’s basically the "financial recipe" a company uses to fund itself.

🧱 Main Components of Capital Structure

⚖️ Why Capital Structure Matters

A company’s capital structure affects:

• 💵 Cash Flow Needs: Can it handle interest payments?
  
  

• 📉 Risk: Too much debt = financial distress.
  
  

• 🧾 Tax Benefits: Interest on debt is often tax-deductible.
  
  

• 📈 Shareholder Returns: The structure can influence stock prices and dividend policies.
  
  

📊 Debt vs. Equity – Key Differences

✅ Balanced capital structure = financial flexibility + minimized cost of capital. 

🛠️ How Companies Manage Debt (Debt Management)

Good debt management means using borrowed money wisely and sustainably. Here's how companies handle it:

1. 📏 Setting Debt Limits

• Companies set a maximum debt-to-equity ratio to avoid excessive leverage.
  
  

• Common ratio: Debt/Equity or Debt/Assets
  
  

2. 📊 Monitoring Interest Coverage

• Companies use the Interest Coverage Ratio =

• A high ratio = more ability to pay interest.
  
  

3. 💳 Managing Repayment Schedules

• Spread out repayments to match cash flow cycles.
  
  

• Avoid “balloon payments” (big final payments) unless planned.
  
  

4. 💬 Negotiating Loan Terms

• Lower interest rates and longer terms reduce pressure.
  
  

• May include covenants (rules set by lenders, e.g., “Don’t take on more debt”).
  
  

5. 🔄 Refinancing

• Replace old loans with new loans at better rates.
  
  

• Helps manage cash flow and reduce interest cost.
  
  

🧮 Accounting for Debt and Equity

📒 On the Balance Sheet:

🧾 On the Income Statement:

• Debt → Interest expense is recorded
  
  

• Equity → Dividends paid to shareholders (not shown as expense but in retained earnings)
  
  

📉 Example: Capital Structure in Practice

A company raises:

• $200,000 in equity
  
  

• $300,000 in debt
  
  

Capital Structure Breakdown:

➡️ This company has a 60/40 debt-to-equity structure, which is common in many industries.

📘 Quick Recap