In corporate law, capital structure refers to the way in which a company finances its operations and assets. This is usually through the use of various instruments either singly or in combination. These could be equity, hybrid securities, debt and other sources of funds. A successful business is one that has a sustainable capital structure, and which is also within the state and federal legal limits.
A common instrument for capital structure is equity. This commonly refers to the earnings that the company has, but can also include stocks and shares. However, it is common to find that this is not sufficient to fund a company’s growth, in which case the equity is supplemented by long term and short term debt. Debt can be an especially useful tool in capital structure provided that its use is regulated carefully.
Capital structures tend to differ from one company to another. The typical type usually comprises a mixture of short term and long term debt, as well as preferred and common equity. During analysis of a company’s capital structure, the debt to equity ratio is used to determine how much risk it is exposed to. Companies that are heavily financed by debt with little equity present more risk to their investors, and are typically described as having aggressive capital structures. This may or may not be a good thing depending on how the company manages the debt.
The success of any corporation heavily depends on its capital structure. This should therefore be well-defined and adhered to, taking into consideration factors such as the maximum risk that investors are likely to tolerate.