CAPITAL STRUCTURE
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The mix of debt and equity a company uses to finance its operations and growth.
Summary
Capital structure refers to how a company funds its business operations and expansion through a combination of debt (borrowed money that must be repaid with interest) and equity (ownership shares sold to investors). Think of it like deciding how to pay for a house - you could pay all cash (equity), take out a mortgage (debt), or use a combination of both. Companies make similar decisions about financing, weighing factors like cost, risk, control, and tax implications. The optimal capital structure balances the benefits of debt (tax deductions, leverage) against its risks (interest payments, bankruptcy risk).
Usage Context
Understanding capital structure is crucial when analyzing company financial health, making investment decisions, studying corporate finance strategy, calculating cost of capital, and evaluating financial risk. It's foundational for topics like financial statement analysis, valuation, and corporate financial management.
Common Confusions
- Confusing capital structure with capital budgeting (which is about investment decisions, not financing)
- Thinking that debt is always bad - moderate debt can actually increase returns to shareholders
- Assuming there's one 'perfect' capital structure for all companies - it varies by industry and situation
- Mixing up market value vs. book value when calculating capital structure ratios
- Not understanding that capital structure affects both risk and return
