Define Capital Structure

by SANTOSH
(VIZIANAGARAM)

Q: What is the meaning of "capital structure"?

A: The term "capital structure" refers to the structure of capital (equity) for a business. Actually more often it refers to the structure of both equity and liabilities (debt) for a business.

In other words, what and how much are the sources of financing for the business?



For example, let's say we have a company that has the following equity and long-term liabilities:

• Ordinary shares $6,000,000


• Preference shares $3,000,000


• Debentures $1,000,000

(Shares are small bits of ownership of a company owned by many shareholders or investors and are classified as equity. Ordinary shares are the most common type of shares, they are like regular shares. Preference shares are simply shares in a company that give more benefits than ordinary shares. Debentures are the debt equivalent of shares - they are long-term liabilities - small amounts of debt that can be bought by an investor).

In the above example the ordinary and preference shares are equity. The capital structure (in terms of equity alone) would be $6 million ordinary shares and $3 million preference shares. Or we could say the capital structure is 66.67% ordinary shares ($6 million ordinary / $9 million total) and 33.33% preference shares ($3 million preference / $9 million total).

Or if we included the liabilities (debentures) in the capital structure we could say that the equity came to $9 million (90%) and the long-term liabilities to $1 million (10%) of the capital structure. Or the capital structure is 90% equity and 10% debt (liability).