Capital structure

The mix of debt and equity a company uses to fund its assets, usually measured at market values as debt divided by debt plus equity. It sets the weights in the weighted average cost of capital and decides how much of a bad year falls on the shareholders.

With a market capitalisation of ₹6,000 crore and ₹2,000 crore of debt, a company has a capital structure of 25% debt and 75% equity.

Debt is cheaper than equity because lenders rank first and interest is tax-deductible, so adding some usually lowers the overall cost of capital. Past a point the expected cost of financial distress, lost customers, constrained investment and the risk of losing the company to its lenders outweighs the tax saving. Where that point falls depends on how steady the cash flows are: a regulated utility can carry far more debt than a cyclical steelmaker or a software start-up.

Companies also drift from any target for practical reasons, using internal cash first, then debt, and issuing equity last, so the current mix often reflects history more than design.

Ask what mix the cash flows can carry.