Capital Structure

Article byRatnesh Sharma
Reviewed byDheeraj Vaidya, CFA, FRM

What is Capital Structure?

Capital structure is the composition of a company’s sources of funds, a mix of owner’s capital (equity) and loan (debt) from outsiders. It is used to finance its overall operations and investment activities. The owner’s capital is in the form of equity shares (common stock), preference shares (preference stock), or any other form that is eligible to control the entity’s retained earnings Retained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the more of the entity. Debt capital is in the form of the issue of bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain more or Please provide us with an attribution link[/wsm-img-crd-tooltip]

In return, investors are compensated with an interest income for being a creditor to the issuer.” url=””]debenturesHow to Provide Attribution?”Debentures of loans Loans A loan is a vehicle for credit in which a lender will give a sum of money to a borrower or borrowing entity in exchange for future morefrom a financial banker. Capital structure is a very critical factor in the case of project financingProject FinancingProject Finance is long-term debt finance offered for large infrastructure projects depending upon their projected cash flows. Moreover, an investor has to form a Special Purpose Vehicle (SPV) to acquire the same. read more. The bankers are concerned about the initial percentage of funding to the proposed project and usually assist with up to 70% of the project cost.

Key Takeaways

  • Capital structure refers to the composition of a company’s sources of funds, a combination of owner’s capital(equity) and loan (debt) from outsiders. One may use it to finance overall business operations and investment activities. 
  • The types of capital structure are equity share capital, debt, preference share capital, and vendor finance.
  • In addition, it ensures accurate funds utilization for business. The right capital structure level decreases the overall capital cost to the highest level. Also, it increases the public entity’s valuation.
  • If the debt-equity ratio is low, the firms may borrow the new debt amount. If the company has adequate cash reserve, it can repay the existing debt and borrow the new debt capital at a reduced interest rate.

Capital Structure Explained

Capital structure is a specific mix of equity and debt used to finance a company’s operations and assets. From a corporate finance perspective, equity capital provides a more long-term and flexible source of finance for the company’s growth prospects and daily transactions.An optimal capital structure comprises of enough balance between equity and debt. Debt for an organization includes all short-term and long-term loans that the company has to repay. Equity is the combination of common and preferred shares and their retained earnings.

Let us understand the intricacies of this concept through discussions about types, formula, examples, and importance.

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The formula of capital structure formula quantifies the amount of equity and the amount of outsiders’ capital at a point in time. We can do such calculations as a percentage of each money to the total capital or debt-to-equity ratioDebt-to-equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. read more.

Let us calculate capital structure using the Debt/Equity formula.

Capital Structure Example 1

A company with a higher debt-equity ratio is a highly leveraged company.


Let us understand the concept in detail through the couple of examples with calculation below which will help us understand the optimal capital structure.

You can download this Capital Structure Excel Template here – Capital Structure Excel Template

Example #1

A company has proposed an investmentInvestmentInvestments are typically assets bought at present with the expectation of higher returns in the future. Its consumption is foregone now for benefits that investors can reap from it more in a project with information about its project cost. The project will be financed 20% by the common stock, 10% by the preferred stock, and the rest by the debt. The company intends to understand its calculations.

Example 1.1


Capital Structure Example 1.2
Example 1.3

Debt Equity will be:

Capital Structure Example 1.4

Debt Equity Ratio = (1794/769) = 2.33.

Example #2

The capital structure of the entity over the projected years is as follows: –

Capital Structure Example 2
Example 2.1

Note: The debt-equity share has been reducing over the years since the reserves increased, and the company can repay its debt holders.


Based on the nature of business, management style, and the risk appetite of the organization, the capital structure theory might differ. Let us understand the different types through the discussion below.

Capital Structure

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For eg:
Source: Capital Structure (

#1 – Equity Share Capital

#2 – Debt

#3 – Preference Share Capital

#4 – Vendor Finance


Let us understand the importance of the capital structure theory through the points below.

Frequently Asked Questions (FAQs)

What are the factors affecting capital structure?

The factors affecting capital structure are the firm’s capital cost, size, nature, capital markets situation, ownership, and debt-to-equity ratio.

What is the capital structure financial management?

Capital structure financial management refers to the definite combination of debt and equity that one may use to finance the company’s business operations and assets. Equity may prove more expensive to corporates and can be a capital’s permanent source with higher financial elasticity.

What are the determinants of capital structure?

The determinants of capital structure are profitability, size, growth, tangibility, tax shield, and age.

What is the capital structure decision?

Capital structure decisions involve long-term finds sources like debt and equity capital. It combines different long-term funds sources, divided into debt and equity. Therefore, it is also known as the company’s “Debt Equity Mix.”

Recommended Articles

This article is a guide to what is Capital Structure. We explain its examples, formula, types, calculation, and its importance. You may learn more about financing from the following articles: –