Difference between Capital Structure and Financial Structure

What is Capital Structure?

Capital structure combines instruments like shares (both equity and preference), debentures, bonds, long-term loans, and retained earnings. The company gets these funds from individuals and institutions to sustain and grow its operations.

A robust capital structure is crucial for the company because of the following reasons:

  • It helps firms increase the market price of their shares and securities, leading to a higher valuation of the company.
  • It also prevents over or under capitalisation of the available funds.
  • It helps the company give a higher return to its stakeholders.
  • It helps to maximise the shareholders’ capital while minimising the cost of capital for the company.
  • It gives the company an option to increase or limit its debt borrowings without much trouble.

What is Financial Structure?

Financial Structure includes both long-term and short-term financial instruments to raise capital for the organisation. All the items present in the Liabilities side of the Balance Sheet are a part of the Financial Structure.

Types of Financial Structure

Financial Structure has two parts – Equity and Debt. We will discuss both of them below:

  • Equity Capital – Equity Capital is what the company owes to their shareholders and owners. It is of two types: Contributed capital and Retained earnings. Contributed capital is the money that both owners and shareholders have invested in the company. Retained earnings are a part of the company’s profits that is kept aside for reinvesting in the business.
  • Debt Capital – Debt Capital is the money borrowed by the organisation from individuals and institutions. It includes Long-term Bonds that have extended repayment terms, and the borrowers have to pay interest on them periodically. The principal amount is payable at the time of maturity. It also includes Short-term commercial instruments, which on the other hand, have a lesser repayment period, and firms use it to raise capital for their immediate needs. A firm needs a mixture of these two financial tools to finance its operations.

Difference between Capital Structure and Financial Structure

The main differences between Capital and Financial Structure are as follows:

Capital Structure

Financial Structure

Definition

Capital Structure is a combination of different types of long-term sources of funds.

Financial Structure is a combination of different types of long-term as well as short-term sources of funds.

Balance Sheet

The Capital Structure is a part of the Liabilities section of the Balance Sheet.

The Financial Structure includes all the items in the Liabilities section of the Balance Sheet.

Scope

Capital Structure has a narrower scope compared to Financial Structure.

Financial Structure has a broader scope compared to Capital Structure.

Financial Instruments

The instruments under Capital Structure include the following:

  • Equity Shares
  • Preference Shares
  • Debentures
  • Long-term Borrowings
  • Retained Earnings

The instruments under Financial Structure include the following:

  • Equity Shares
  • Preference Shares
  • Debentures
  • Long-term Borrowings
  • Retained Earnings
  • Account Payable
  • Short-term Borrowings

Conclusion

Although there are differences between Capital Structure and Financial Structure, all organisations depend on them to raise funds to sustain and run their business successfully. Companies must ensure that their financial strategy must be flexible enough to cope with the changing scenarios within the industry. At the same time, it should also be sound enough to prevent the risk of insolvency.

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