What does capital structure refer to in a company?

Capital structure is a crucial concept in financial management that refers specifically to the mix of debt and equity a company uses to finance its operations and growth. This mix can significantly influence a company's cost of capital, risk profile, and overall financial stability.

Utilizing debt, such as loans or bonds, can allow a company to leverage its capital, potentially increasing returns on equity; however, it also introduces fixed obligations that must be met regardless of the company's performance. Conversely, equity financing, which can come from issuing stock or using retained earnings, provides a cushion against financial distress but may dilute existing ownership and control.

Understanding a company's capital structure helps stakeholders assess its financial health and strategy. For instance, a company with a high proportion of debt might be viewed as riskier in unstable economic conditions. Hence, recognizing capital structure helps in evaluating a firm's ability to generate returns and sustain operations over the long term. This understanding of capital structure is fundamental for anyone studying financial management principles.