Leverage, capital structure rules and financing principles

Viewed historically, the financing policy of German companies can be characterized by a continuous process of substituting equity for debt. As part of this increasing debt, the more expensive but flexible equity factor is partially replaced by the cheaper but inflexible debt capital factor. Check kiss918 site while learning classic financing rules.

Classic financing rules

In the context of the classic financing rules in business administration, a distinction must be made between the horizontal and vertical capital structure rule.

Horizontal capital structure rule

The horizontal capital structure rule requires a congruence of the maturity of the capital provision with the commitment period of the assets so that the fixed assets are to be financed with equity capital and possibly with long-term debt capital and the current assets with short-term debt capital.

Vertical capital structure rule

The vertical capital structure rule requires the equity capital to correspond to the creditor capital and thus a debt ratio of one. These balance sheet structure standards are primarily intended to ensure the company’s liquidity and are in this respect oriented towards the interests of the creditors with regard to securing interest and principal payments.

It should be noted that strict adherence to these financing rules from a liquidity point of view is normally not necessary and often insufficient in the event of a crisis, since there is income between the accounting categories of assets and capital, to which the rules refer, and the financial categories that determine liquidity and spending only have a very indirect relationship. In this respect, the accounting categories can only inadequately reflect the financial status of a company, since the following differences exist between assets/capital on the one hand and income/expenditure on the other:

In principle, there is no correspondence in the temporal distribution of the two categories, since the capital structure rules assume that the revenue process does not generate cash in the event of a crisis. Particularly in crises, parts of the current assets that are supposedly tied up for a short time turn out to be partly unsaleable, while isolated parts of the fixed assets may be available as liquidity reserves that are available at relatively short notice.