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Capital structure

Capital structure is the company's mix of equity and debt it uses to finance itself.

Expanded Definition

Capital structure, capitalization, invested capital. They all mean pretty much the same thing -- how much money and from what sources the company has used to build itself up and purchase its assets.

It is the total amount of debt and equity, which can be further broken down into retained earnings, additional paid-in capital, common stock, and preferred stock the company is carrying on its balance sheet. Each of these items is a source of capital for the company.

  • Debt: Borrowings from a bank or from investors in the form of bonds.
  • Equity: Consisting of:
    • Retained earnings: The amount of net income the company has kept and not paid out as dividends to shareholders. It reinvests in itself.
    • Additional paid-in capital: The amount above and beyond the par value of stock the company has received from selling or issuing shares of itself.
    • Common stock: Ownership shares of itself.
    • Preferred stock: Special shares, usually without voting rights and with special dividends.

The company uses these sources of capital to purchase assets to generate revenue and net income. Ideally, it would earn a return on this invested capital that is higher than its cost. If it doesn't, then the company is destroying capital and will require either future infusions of more capital or go out of business (eventually). Because the cost of the different components of the invested capital varies (primarily debt and equity, with debt being less expensive), the company's cost of capital is a weighted average cost of capital or WACC.

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