Q.What is meant by Capital Structure? State its basic components.

This question checks whether a student can both define capital structure and name what it is actually made up of.

Capital structure refers to the mix or proportion of different long-term sources of funds that a company uses to finance its total assets. It is narrower than the overall financial structure, which also includes short-term liabilities, since capital structure looks only at permanent, long-term sources.

The basic components that make up a firm's capital structure are, first, owned funds, which include equity share capital (the primary ownership capital carrying voting rights and residual claim on profits), preference share capital (carrying a fixed rate of dividend and priority over equity in payment), and reserves and surplus (profits retained in the business rather than distributed as dividend). Second, borrowed funds, which include debentures and other long-term loans raised from banks or financial institutions, on which the firm must pay a fixed rate of interest regardless of its profit level. …