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What Is the Connection between Capital Structure and Debt Structure?

Osmand Vitez
Osmand Vitez

The connection between capital structure and debt structure is quite simple; the latter is simply part of the former. Capital structure represents the mix of equity and debt monies used to finance large parts of a company’s operations. Therefore, debt structure is the loans and bonds that make up the debt portion of this mix. Capital structure and debt structure are closely monitored as few companies desire heavy debt loads on their balance sheets. Too much debt indicates an overleveraged company, with the company responsible for repaying the debt regardless of its current revenue stream.

Many different calculations go into the review and creation of a company’s capital structure. The most common pieces that a company may include here include common and preferred stock and short and long-term banks loans and bonds. In some cases, one individual project may have both equity and debt monies that help finance the individual activities within the project. Other times, only one item from the capital structure is necessary. Corporate finance analysts, accountants, and business analysts are all individuals who can review a company’s capital structure and debt structure.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

Bank loans are often the most common forms of debt in a company’s debt structure. Both small and large organizations can use these loans for financing operations as they are often readily available. Large organizations also have the option of offering bonds, which are investments sold to willing buyers in an open market. Bonds can be dangerous as they represent legal obligations that must be repaid regardless of the company's ability to do so. Even business liquidation can rarely stop the claim bond investors have on a company’s assets, making these a very risky inclusion in a capital structure and debt structure.

The debt-to-equity ratio is a common tool both internal and external stakeholders use to review a company’s capital structure and debt structure. The basic formula for this financial ratio is total liabilities divided by total shareholder’s equity, with a minor difference being the use of long-term debt in place of total liabilities. A high ratio result indicates an aggressive company that finances operations through debt, with the hopes of extended growth in the picture. The earnings a company must generate to ensure profitability can be quite high as well, however. Interest payments alone from debt can quickly erode any benefits brought through debt financing in capital structure and debt structure.

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