Capital Structure

Reviewed by Sujaini | Updated on Aug 27, 2020

What is Capital Structure?

The capital structure is the specific combination of a company's debt and equity to fund its overall growth and operations. Debt comes in the form of bond issues or loans and investment can come in the form of common stock, preferred stock, or earnings that are retained. Often, short-term debt is considered a part of the capital structure.

Breaking Down Capital Structure

The balance sheet includes both debt and equity. With this debt and equity, company properties, which are also listed on the balance sheet, are purchased. Capital structure can be a combination of the long-term debt, short-term debt, common stock, and preferred stock of a company. In assessing the capital structure, the proportion of a firm's short-term debt against long-term debt is considered.

If investors refer to capital structure, they most likely refer to the debt-to-equity (D/E) ratio of a firm, which provides insight into how risky the borrowing activities of a company are. A business that is mostly funded by debt typically has a more conservative capital structure and therefore presents a more significant risk to investors. However, this risk may be the primary source of growth for the company.

Measures of Capital Structure

Organisations that use more debt than equity to finance their assets and support operational operations have an aggressive capital structure and a high leverage ratio. A company that charges more equity than debt for assets has a low leverage ratio and a conservative capital structure. A high leverage ratio and an aggressive capital structure result in higher growth rates as well, whereas a traditional capital structure will lead to lower growth rates.