Capital Structure

What is Capital Structure?

The Capital structure refers to a combination of debt and equity employed by a corporation in order to finance its development and operations. Debt refers to bond, loans and equity refers to common stock, retained Earnings and preferred stocks. Working capital requirements are also a part of the capital structure.

The capital structure is a mixture of long-term and short-term debt. Debt and equity can be found on the corporation’s Balance Sheet. It is important to note that while analysing a company’s capital structure, the proportion of short-term versus long-term debt is taken into consideration. The debt to equity ratio usually provides insight into understanding how risky a corporation’s borrowing practices are.

Debt and Equity

When a corporation has been financed by debt largely, the capital structure is impacted it this poses as a risk to investors. However, it is important to note that debt is one of the main ways a corporation can raise funds in the capital Market. Various corporations actually are majorly advantaged by debt because of tax advantages. Like the interest payments which are the result of debt causes tax to reduce.

Debt allows corporations to retain ownership, which equity doesn’t. Equity allows the investors to take partial ownership in the concerned corporation. Equity is far more expensive than debt when the markets have low-interest rates. But you don’t have to pay back equity, which is a major benefit for the corporations when it comes to declining earnings. Equity represents the owners’ claim on the future earnings of the corporation.

The goal of a corporation should be to identify the right mix of debt and equity in order to finance its operations. This is also known as the optimal capital structure. Successful corporations use the right mix of both, which attracts investors to a large extent. Analysts use the debt to equity rate to compare the capital structure, which is calculated by dividing total liabilities by total equity.