Define Capital Structure
What is the meaning of "capital structure"?
The term "capital structure" refers to the structure or combination of capital (owner's 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:
Shares are small bits of ownership of a company owned by many shareholders or investors and are classified as equity.
- Ordinary shares $6,000,000
- Preference shares $3,000,000
- Debentures $1,000,000
Ordinary shares are the most common type of shares, they are like regular shares and are also known as common stock.
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.
With the liabilities (debentures) included, we could say that the equity comes to $9 million (90%) and the long-term liabilities comes to $1 million (10%) of the capital structure. Or the capital structure is 90% equity and 10% debt (liabilities).
Do you have your own examples of capital structure or questions on this?
Let us know by adding a comment below.
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