What is meant by the term "capital structure"?

The term "capital structure" refers specifically to the combination of debt and equity financing that a company uses to fund its operations and growth. This concept is fundamental in finance because it reflects how a firm finances its overall operations and growth through different sources of funds.

A balanced capital structure is important because it can affect the company's risk profile, cost of capital, and ultimately its valuation. Companies might choose different combinations of debt (such as loans and bonds) and equity (such as stocks) based on their growth strategies, risk tolerance, market conditions, and financial goals. A heavy reliance on debt might lead to higher financial risk, while excessive equity financing could dilute ownership and potentially reduce returns on investment.

Understanding capital structure is critical for investors and managers as it directly impacts company performance and financial stability.