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U3 – DISCUSSION QUESTION

Introduction

Corporate finance is the sources of finances for a company, managers’ actions on the value of the firm, as well as the capital structure of the corporations. The leadership of a firm determines the primary objective to enhance the quality of productivity, increase the value of the company to the shareholders, improve analysis tools, and allocate financial resources fairly and equitably to all departments. On that note, capital structure entails the manner in which an organization enhances its performance through established essential financial strategies addressing matters related to debts, equity, and hybrid securities of the company. In the United Kingdom, most multinational corporations such as HSBC Holdings, TESCO, and British Airways utilise financial strategies that enable them to steer through the corporate lifecycle. This paper addresses the effects of capital structures and the corporate lifecycle in a company’s financial wellbeing especially in the airlines, retail, software, and baking industries.  

Capital Structure

Similarities

Capital structure entails a company’s equity and debt capital, financial leverage, as well as enterprise value to enhance a balance between the expenditure and income generated. The debt-to-equity ratio is a significant part of the capital structure that indicates the risks associated with a company (Baker & Martin, 2011).  In most European countries, equity is expensive compared to debts and does not require any payback (European Central Bank, 2009). In fact, equity is considered a claim of future earnings generated by a company such as the HSBC Holdings Plc, Ability Plus Software, British Airways, and the TESCO. Most software, financial, airlines, and retail companies use debt to raise capital in the capital markets. In addition, financial leverage and enterprise value play a crucial role in defining the capital structure of financial, technology, retail, and airlines industries (Siddik, Kabiraj, & Joghee, 2017). Most companies have similarities in the financial leverage they utilise in their capital structure. Amount of debt in a company is determined through the application of financial leverage ratio such as the debt-to-total-capital. Financial leverage for most companies ranges from 0.37 to 0.47. In the four industries in the UK, the management considers debt capital less compared to equity capital, which is sustained by low interest rates.

Differences

Banks are mostly affected by the conversion of loans and debts into equity since the process is associated with risks that may lead to the dissolution of the firms. The HSBC Holdings Plc combines corporate finance knowledge with market intelligence and insights to offer capital solutions to the bank and its clients. Other industries usually affect the liquidity of the banks when they convert their perceived loan into share capital with an aim of overcoming the payment of the principal amount borrowed and interest (Maverick, 2015). This scenario showcases the alarming difference in equity capital for the airlines, retail, finance, and software development industries. Nevertheless, financial leverage determines the ratio that banks employ in lending out money especially to multinational firms and corporate. The leverage ratio also determines the amount of capital that a bank has to use to finance its assets based on the total amount it has borrowed (Maverick, 2015). The banks such as the HSBC Holdings Plc act as the institution that lender its clients including the Ability Plus Software, British Airways, and TESCO Plc.

Example of a Capital Structure for HSBC Holdings (Retrieved from https://www.marketwatch.com/investing/stock/hsbc/profile)

Total Debt to Total Equity

255.58

Total Debt to Total Capital

71.88

Total Debt to Total Assets

17.03

Long-Term Debt to Equity

97.88

Long-Term Debt to Total Capital

27.53

Corporate Lifecycle

Influence or Limit of Lifecycle Stages in the Choice of Finance

Corporate lifecycle entails the period between the inception of an organisation up to its termination and all associated factors affecting the company.  The lifecycle also describes the proposed sequences of technological and productivity advances in the company as opposed to the occurrence of events randomly. However, the lifecycles are at some point not perfectly predictable since they differ among firms. The life cycles are not perfectly predictable, although they have certain characteristics shared among companies. According to Bulana and Yanb (2009), corporate lifecycle occurs in stages that include creative, delegation, directional, coordination, and collaboration expansion to enhance the productivity of a firm. Most firms in the United Kingdom have high and low growth phases that affect their performance. According to Bulana and Yanb (2009), the stages indicate the effects of dividends in relation to empirical evidence on dividend policy as an attribute of the life cycle theory. On that note, the maintenance of a zero payout ratio during the initial phase enables value maximisation.  

The stages of corporate lifecycle affect the choices of finance in a positive and negative manner based on the decisions that a firm makes. The age of a firm and stage of development plays a crucial role in determining financing costs for the company (Harrison & Estelami, 2014). Evidently, the performance of a company worsens as it matures and gets to the late stages of the life cycle. The level of organisation rigidities, firm endowments, and the proliferation of seniority rules determine a company’s performance. It is believed that a firm’s underperformance occurs approximately 40 years after incorporation and 15 years after listing (Harrison & Estelami, 2014). At this point, the company’s profit margins lower, sales growth reduces, and expenditure costs increases. Other factors that affect a company’s choice of finance based on life cycle include manager and industry age, corporate governance, time-varying risk, and ownership structure.

Conclusion

Financial, technology, retail, and airline industries are the most affected by corporate finance and lifecycle in the United Kingdom. However, some firms perform better than others do due to the effects of competitive advantage. Capital structures in the firms take advantage of bankruptcy cost as an offset of using debt as a tax shield. Most companies consider costs and benefits affecting the companies’ performance in determining the level of sustainable debt and equity finance. The capital structures are also affected by the corporate lifecycle since some of the phases such as the prime effect the choice of finance strategy that a company utilises. The corporate lifecycles stages have differing effects on the choice of finance for a company. However, it is evident that the choice of finance is usually determined by the company’s performance and age. Young firms perform better than old ones, especially those exceeding 15 years after incorporation. This is an indication of the effects of the lifecycle, which is usually highest at the prime stage of the company.   

Reference list

Baker, H. K., & Martin, G. S., 2011. Capital structure and corporate financing decisions: theory, evidence, and practice. Hoboken, NJ: Wiley, John Wiley & Sons, Inc.

Bulana, L., & Yanb, Z., 2009. Life Cycle Effects in Firm Financing Choices. [Pdf] Available at: <https://www.researchgate.net/publication/237210753_Life_Cycle_Effects_in_Firm_Financing_Choices> [Accessed 15 December 2018].

European Central Bank, 2009. The determinants of Bank Capital Structure. [Pdf] Available at: < https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1096.pdf > [Accessed 15 December 2018].

Harrison, T., & Estelami, H., 2014. The Routledge Companion to Financial Services Marketing. New York, NY: Routledge.

Maverick, J. B., 2015. Why does Debt to Equity Ratios Vary From Industry to Industry? [online] Available at: < https://www.investopedia.com/articles/investing/083115/why-do-debt-equity-ratios-vary-industry-industry.asp> [Accessed on 15 December 2018].

Siddik, N., Kabiraj, S., & Joghee, S., 2017. Impacts of Capital Structure on Performance of Banks in a Developing Economy: Evidence from Bangladesh. International Journal of Financial Studies, 5(13), pp. 1-18. DOI:10.3390/ijfs5020013

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