The Link Between Capital Structure and Financial Flexibility

A companys capital structure its ratio of debt to the sum of debt and equity market value — is important for assessing the organization’s financial flexibility and ability to access capital in the future.If the company has a high debt-to-equity ratio, for instance, it’s said to be highly leveraged and may have fewer opportunities to borrow funds to support innovation. The ratio also can influence investors’ decisions regarding the company.Determining an optimal capital structure has been for decades a Holy Grail for practitioners and academics alike. Research documents that profitability, company size, and macroeconomic conditions are among the many factors that influence managers in making these decisions.Surveys of CFOs in the United States and Europe, however, have ranked maintaining financial flexibility as the primary determinant in setting a company’s financing policy. It’s defined as the company’s ability to take advantage of new investment opportunities as they come along, or sustain ongoing projects, via borrowing.