Capital Structure | A-Level & IB Business

Summary

This video explains the concept of capital structure, focusing on the mix of debt and equity that businesses use to finance themselves. It defines capital structure as the proportion of debt (such as bank loans and debentures) compared to equity (share capital and retained profits). The script highlights how different businesses can have varying capital structures, with one example showing a business with more equity, while another uses more debt. It also discusses the trade-offs between using debt and equity, with debt being cheaper when interest rates are low but riskier, while equity is more stable but may limit returns for shareholders.

Takeaways

• 😀 Capital structure refers to the mix of different types of finance a business uses.
• 😀 The key components of capital structure are debt and equity.
• 😀 Debt financing includes long-term sources like bank loans and debentures.
• 😀 Equity financing consists of share capital invested by owners and retained profits kept within the business.
• 😀 The capital structure determines the proportions of debt and equity a business uses for financing.
• 😀 Business A has more equity, with 800,000 pounds in equity versus 200,000 pounds in debt.
• 😀 Business B has a higher debt-to-equity ratio, with 600,000 pounds in debt compared to 400,000 pounds in equity.
• 😀 There is no universally right or wrong capital structure; it depends on the business’s needs and risk tolerance.
• 😀 Low interest rates make debt a cheaper and attractive option for financing, especially for businesses with strong cash flows.
• 😀 Some businesses prefer equity financing to avoid the risks associated with debt, such as paying interest and repaying loans.
• 😀 Retained profits can be an attractive source of equity financing, as they don't require paying dividends to shareholders.

Q & A

What is capital structure?

Capital structure refers to the mix of debt and equity that a business uses to finance its operations and growth.

What are the two main types of finance sources in capital structure?

The two main types of finance sources are debt and equity.

What are examples of debt in a business's capital structure?

Examples of debt include bank loans, long-term loans, and debentures.

What makes up the equity side of a business's capital structure?

Equity consists of share capital invested by shareholders and retained profits kept in the business.

How is a business's capital structure determined?

A business's capital structure is determined by the proportion of debt and equity it uses to finance its operations.

What is the debt-to-equity ratio?

The debt-to-equity ratio is a comparison of the total amount of debt to the total amount of equity in a business's capital structure.

How does Business A's capital structure differ from Business B's?

Business A has more equity (800,000 pounds) and less debt (200,000 pounds), while Business B has more debt (600,000 pounds) and less equity (400,000 pounds).

What are the advantages of using debt in capital structure?

Debt is often cheaper when interest rates are low, and if a business has strong profits and cash flows, debt can be an effective way to finance growth.

What are the risks associated with using debt in capital structure?

The risks of using debt include the need to pay interest and repay the debt, which can put pressure on a business's cash flow and increase financial risk.

Why might a business choose equity over debt?

A business might choose equity over debt to reduce financial risk, as equity does not require repayment or interest payments, making it a safer option for high-risk businesses.