• 17 Sep 2015

    Strategic Management: Capital Structure Issues for Laundries


    Chief Financial Officer of Health Check Inc., and American Associated Companies, Jon Scala was published in RSA Magazine -September 2015. Click here to read the full article. 

    STRATEGIC MANAGEMENT: CAPITAL STRUCTURE ISSUES FOR LAUNDRIES

    Decisions about capital structure can impact a company’s costs and its ability to pursue acquisitions
    By Jon Scala

    Most operators in today’s textile services market must focus on: 1) optimizing their capital structure, given the low interest rate environment since the financial crisis; 2) longterm growth objectives, and 3) their risk/reward profile. The best capital structure maximizes the business value for its equity stakeholders, but also offers a balance between the ideal debt-to-equity ratio, while minimizing the firm’s cost of capital. In theory, debt financing generally offers the lowest cost of capital due to its tax deductibility and higher lien position on assets. However, it’s rarely the optimal structure, since a company’s risk generally rises as its debt increases. The decision regarding what type of capital structure a company should have is of critical importance because of its potential impact on profitability, solvency and the organization’s ability to grow. Debt vs. Equity—This focuses on the level of debt vs. equity in the overall capital structure. Although debt provides a lower short-term cost alternative, it requires an increased short-term cash outflow (interest & principal payments) necessary to support this obligation. Although every business would look to minimize its cost of capital, this would imply that the capital structure should be 100% debt as it provides a lower cost of capital, tax deductibility and usually a long-term fixed rate cost. But clearly, this is not the case as debt financing requires strong and immediate cash flow to support payments and oftentimes restricts the company’s operational flexibility with financial covenants and restrictions on cash-flow use. Equity provides a more expensive capital cost, but doesn’t require immediate cash payments (except for preferred equity), and return horizons are typically much longer as compared to debt financing. Business Profile—Each type of capital-structure decision ultimately is determined by the profile of the company, which includes long-term growth goals, operational flexibility needed, size and cash-flow. Each of these factors determine the mix between debt and equity as they impact the amount of capital raised and the cost of capital. The financial-services landscape has developed and can be much more complex, diverse and difficult to navigate. Once a decision is made to raise debt, equity or a combination of both, there are a variety of products available, depending on which would provide the most effective blended cost of capital. The chart on page 89 illustrates the various financial products available. Ultimately, management must align its long-term goals with capital-structure decisions. This capital structure strategy should be reviewed frequently, updated and remain flexible with the operational growth and strategic plans of the business. Although capital structure will be a driver for growth, it can also be a detriment if not managed in conjunction with cash flow and operational concerns. Given the historic low interest-rate environment and significant capital requirements of the laundry sector, unique and effective capital structures can be not only operationally successful but can drive competitive effectiveness by allowing businesses to respond quickly and effectively to changes in the marketplace. Click here for the full article.