Capital Structure

Term of the Day - 26 January 2024

Today’s Term is “Capital Structure”.

Capital structure refers to the way a company finances its operations and growth by utilizing a mix of different sources of funds. It involves the combination of debt and equity that a company employs to fund its various activities, such as investments, operations, and expansions. The two primary components of capital structure are debt and equity.

Debt capital represents funds borrowed by the company, which can include loans, bonds, or other debt instruments. The advantage of using debt is that it allows companies to leverage their investments, potentially magnifying returns. However, it also comes with the obligation to repay the borrowed amount along with interest.

Equity capital, on the other hand, involves the funds contributed by the shareholders or owners of the company. This can include common stock, preferred stock, and retained earnings. Equity provides ownership in the company and gives shareholders a claim on a portion of the company's assets and earnings.

The optimal capital structure is a crucial financial decision for a company, as it affects its risk profile, cost of capital, and overall financial health. Striking the right balance between debt and equity is essential to maximize shareholder value and ensure the company's long-term sustainability.