In financial analysis, what does the term "capital structure" refer to?

The term "capital structure" specifically refers to the mix of debt and equity financing that a company uses to fund its operations and growth. This composition is critical because it affects the company's risk profile, cost of capital, and overall financial health. A company with a high level of debt may have greater financial leverage, which can lead to higher returns in good economic times but also poses risks during downturns. Conversely, a structure heavy on equity may be seen as less risky but can be more expensive in terms of capital costs.

Understanding capital structure is essential for investors and analysts, as it provides insights into how a company finances its activities and how that financing strategy may impact its valuation, stability, and growth potential. The evaluation of capital structure also influences decisions related to funding new projects, managing cash flow, and optimizing the balance between risk and return.