What is Capital Structure?
Capital structure refers to the blend of debt and equity a company uses to fund and finance its operations.
How Does Capital Structure Work?
If Company XYZ has completed an initial public offering and a bond offering, we could therefore say that Company XYZ's capital structure includes debt and equity. Bank loans, preferred stock, retained earnings and working capital might also be part of the company's capital structure.
In many cases, discussions of capital structure include references to debt-to-equity ratios, which are one of several ratios that measure the relative weight of different types of capital.
Why Does Capital Structure Matter?
Different types of capital impose different types of risks on a company. For this reason, capital structure affects the value of a company, and therefore much analysis goes into determining what a company's optimal capital structure is. The Modigliani and Miller propositions (created by financial theorists Franco Modigliani and Merton Miller) address this question.