What are the main practical considerations which are likely to influence a firm’s capital structure?
The expected volatility of operating cash flow is a primary consideration. Firms with lower cash flow volatility can often sustain higher leverage, all else being equal. In a low volatility environment, (i) the capital budgeting process is more predictable and (ii) it is less likely that an unforseen event will make a capital call from debt or equity investors necessary. The expected volatility of operating cash flow is a function of the firm’s industry and competitive position within that industry so ultimately who you are, what you do and what your competitors are doing will have important implications for the firm’s financing activity and capital structure decision-making. Driving down a firms’ cost of capital is always a goal and the finance manager will also consider limitations on flexibility, control and equity participation (collateral, covenants, reporting requirements, dilution) when evaluating the cost of issuing debt or equity.
