Analyzing Accounting CPA Letter to Client

Accounting - CPA Letter to Client John Smith Certified Public Accountant Pine Accountants Company Dear Sir/Madam, RE: CAPITAL STRUCTURE OF A NEW CORPORATION When starting a company, there is need for financial capital, which is necessitated for the operation of the business. This financial capital is done either through debt or equity, which make up the company's capital structure. The main issue here is to determine which of these two options are best for your start-up company. Equity financing does have its benefits.

For starters, the funding will be dedicated to your business and the intended business operations. In addition, there will be no hassle for keeping up with the costs of debt finance, which will allow you to use the capital acquired for business activities. More importantly, the equity investors, similar to you, will have a vested interest in the success of the business. Equity financing does not face any issues such as bankruptcy risk. However, it is imperative to note that equity financing does have its downsides.

To start with, raising equity finance takes time and is also costly, which might deter you from the main business activities. Secondly, the prospective investors will demand wide-ranging background information on you and the business. With the company being new, this will limit you. In addition, depending on the equity investors, you might have to lose a great extent of power to make decisions regarding the management of the company (Damodran, 2003). There are advantages in using debt for financing. One of these advantages is tax savings.

Debt financing aids in lowering a company's taxes for the reason owing to permissible interest subtractions. In accordance to taxation rules and regulations, interest payments are allowed as expense subtractions against returns so as to reach taxable proceeds. This means that the lesser the taxable proceeds, the fewer the amount of taxes that a firm pays. In contrast, this does not apply to equity financing. The dividends that are paid out to equity owners are non-tax-deductible and have to be allots from the income that is already taxed.

As a result, the tax savings aid to further bring down cost of debt financing faced by a company, which is a benefit that equity funding does not have (Marsh, 1982). Another advantage is cost reduction. In comparison to equity financing, debt financing does decrease the cost of financing. Therefore, more often than not, companies include debt in their capital structure in order to decrease the average cost of financing. The other advantage is profit retention.

Despite the fact that debt might bring about pressure with respect to covering interest payment commitments, it helps in retaining more profits within the company in comparison to using equity financing. In debt financing, the company will only need to pay the interest amount from their profits. In contrast, with equity financing, this is largely shared with the equity investors. Another important advantage is financial leverage. Debt financing is beneficial for the company since the owner.