Corporate Capital

Corporate capital is the mix of assets or resources a company can draw on in financing its business. In deciding on and managing their capital structures, company managements have important decisions to make on the relative proportions of debt and equity to maintain.

The types of capital a corporation has available to it take several forms. Equity capital is one broad type with multiple components. Common shares and preferred shares issued as well as paid-in-capital, the par value of all issued stock, are part of a company’s equity capital. Retained earnings, profits that have been reinvested in in the business instead of paid out to shareholders, are another. On the debt side, borrowings include fixed income securities such as loans, bonds and notes payable, are another. A company’s capital structure might also include hybrid securities such as convertible notes.

The decisions a company makes with respect to its corporate capital can affect both its access to and cost of financing, tax liability (because of the favorable tax treatment, or tax shield, debt receives), its credit rating, and ultimately its liquidity. In coming up with an optimal corporate capital structure companies generally give significant weight to how much flexibility, in maintaining ownership control, financing and managing the business, a given structure will provide them.

How a company manages its corporate capital can reveal a lot about the quality of its management, financial health and operational efficiency. It’s also an important part of valuation. For example, a company whose retained earnings are growing might signal one with high growth prospects, for which it expects to need to use those accumulated earnings. It might signal one operating in a capital-intensive sector that needs to retain most of its profits rather than paying them out as dividends or returning them to shareholders via buybacks. It might also indicate a company with a lack of profitable investment opportunities. For these reasons, retained earnings should always be reviewed in combination with other metrics of a company’s financial health.

Key ratios to calculate for these purposes are total debt to equity, and long-term debt to equity. Both can provide a picture of a company’s financial position by revealing how much financial leverage or risk is present in the capital structure. The level and trend of the ratios over time is important. Also important is how they compare to other companies operating in the same industry. Overly leveraged capital structures can point to developing or potential liquidity problems. Under leveraged structures might mean a company’s cost of capital is too high.