What does the term "capital structure" refer to?

The term "capital structure" specifically refers to the mix of debt and equity financing used by a firm to fund its operations and growth. This mix is crucial because it affects both the risk and return profile of the company. Debt financing typically involves loans or bonds that need to be repaid with interest, which can leverage the firm's capital to generate higher returns on equity. Conversely, equity financing involves raising capital by selling shares of the company, which does not require repayment but does dilute ownership.

Understanding a company's capital structure is critical for assessing its financial health and risk-level. A firm with a higher proportion of debt may face greater financial risk, particularly in economic downturns, while one with more equity may have greater financial stability but potentially lower returns on equity. Thus, capital structure plays a vital role in a company's overall financial strategy, impacting investment decisions, cost of capital, and shareholder value.