What does capital structure refer to?

Capital structure refers to the mix of debt and equity financing used to fund a company's operations and growth. It encompasses how a firm decides to finance its overall operations and growth through the use of different sources of funds, such as loans (debt) and investments from shareholders (equity). A well-thought-out capital structure is crucial because it affects a company’s risk profile, returns on investment, and overall financial stability.

When a company leverages debt, it can potentially increase its returns due to the lower cost of borrowing compared to equity; however, too much debt can also lead to higher risk, particularly if business earnings fluctuate. Conversely, relying solely on equity may dilute ownership and increase the overall cost of capital. Therefore, finding the right balance between debt and equity is key for optimizing financial performance and maintaining solvency.

The other options do not accurately define capital structure. Resource allocation pertains to how a company distributes its limited resources for various projects or departments, financial statement analysis focuses on assessing a company's financial health rather than its funding strategies, and profit distribution relates to how earnings are paid out to shareholders rather than how those earnings were financed.