What is Capitalization Structure?
Capitalization structure refers to the proportion of debt and equity in the capital configuration of a company. Capital is how a company funds itself. Equity is a piece of ownership in the company. This usually occurs by the company issuing stock. Debt is a loan issued to the company by an investor. These loans usually occur in the form of a bond issuance. The capital structure shows how much of a company's funding has been granted through the issuance of ownership shares or by taking loans.
Equity shares and bonds each have a different effect on the company's finances, taxes paid and obligations for future revenues. A company's capitalization structure has a significant bearing on measures of its profitability and financial strength, such as net profit margin, return on equity, debt-equity ratio, interest coverage and so on.
Capitalization structure is also known as capital structure or cap structure.
Understanding Capitalization Structure
While formulating or amending its capitalization structure, a company has to consider the pros and cons of various sources of capital. For example, equity capital is dilutive but places fewer demands on the financial strength of a company. On the other hand, interest payments on debt are generally tax-deductible, but debt increases leverage and, hence, the risk profile of the company.
Although firms in the same business sector will generally have a similar capitalization structure, it varies widely across different sectors. For example, companies in the technology and biotechnology sectors have a capital structure that consists almost entirely of equity or common stock, since they have few tangible assets that can be used as security for debt. On the other hand, debt forms a significant proportion, often exceeding 50%, of the capitalization structure of utilities, due to the capital-intensive nature of their business.