What does capital structure refer to in financial terms?

Capital structure refers to the mix of debt and equity that a company employs to finance its operations and growth. Understanding capital structure is crucial for analyzing a company's financial stability and risk profile. It represents how a firm funds its overall operations and growth through different sources, which can include long-term debt, short-term debt, common equity, and preferred equity.

This combination affects the cost of capital and the financial risk faced by the company. A company with a higher proportion of debt in its capital structure may incur higher risk due to fixed interest payments, while a company with more equity may have more flexibility but could dilute ownership. Therefore, an optimal capital structure balances risks and costs, aiming to maximize the firm’s value.

The other concepts mentioned do not capture the essence of capital structure. Total assets relate to what the company owns rather than how it is financed. Dividend policies pertain to how a company manages its profits and distributions to shareholders, and the rate of return on investments concerns the earnings generated relative to their costs, which does not directly define how a firm finances its operations.