What Capital Structure Is and How It Works
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What Is Capital Structure?
Long-term debt: Usually debts held for at least 12 months, which may include bonds, lines of credit, and bank loans Short-term liabilities: Debts scheduled to be paid off in the next year or less, which may include short-term bank loans and commercial paper
Common equity: Stock owned by founders and (if applicable) employees Preferred equity: Stock owned externally. Preferred stockholders are in a higher tier than common stockholders when it comes to claiming dividends or assets
Types of Capitalization Structures
High Leverage
Tends to cost owners less than equity Fixed repayment schedule Maintains current ownership of company
Lower revenue could diminish company profitability Too much debt leads to risk of default Has to be paid back, as opposed to equity
Low Leverage
Greater financial stability No fixed payments Operational flexibility
Could hinder growth Owner loses some degree of ownership and control Paying dividends can eat into profits
How To Calculate Capital Structure
First, add up all of the outstanding debt. Then add up the total amount of capital from equity sources. Finally, divide the debt by the equity to find the ratio.
What Is the Best Capital Structure?
What Is Recapitalizing?
Reduce Debt
Increase Debt
The Takeaway
About the Author
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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