Difference Between Cost Of Capital and Capital Structure (With Table)

The financial world is incredibly broad and covers several aspects such as trading, insurance, corporate finance, derivatives, and indicators. All of them are necessary to run the country’s economy.

Two of the most critical accounting terms are the cost of capital and the capital structure. The capital cost of a company applies to the cost of raising additional capital money. In contrast, the capital structure calculates returns that are required by investors that form part of a system of ownership of the firm.

Cost Of Capital vs Capital Structure

The difference between capital structure and capital costs is that capital costs are essential in determining the corporate capital structure. The evaluation of the optimum financial structure of the company can be challenging because the corresponding benefits and drawbacks are correlated with both debt and equity funding.

The Cost of capital helps shape the business structure of the organization, evaluating potential investments and measuring financial results. A firm’s income is smaller, its investor risk is more serious, and if the cost of capital is high, the financial structure is imbalanced. The capital cost components apply to each source of funding, including debt cost, equity costs, cost of retained profits, and share capital costs.

The Capital Structure applies to the amount of debt and/or equity used by a company in financing its activities and properties. The financial structure of a company is usually expressed as a debt-to-equity ratio. Debt and equity funds support the company’s activities, capital spending, procurement, and other investments. Companies tend to decide whether they want to use loans or equities to fund operations, and management is going to balance both to find the optimum capital structure.

Comparison Table Between Cost of Capital and Capital Structure

Parameters Of ComparisonCost of CapitalCapital Structure
DefinitionInvestments in a single business are subject to the planned capital structure.The capital structure is the mix of a company’s debt and equity to fund its overall operations and expansion.
Utility Alternative investment evaluation, financial results evaluation.Weighted components of cost of capital
ComponentsDebt payments, venture capital costs, retained benefit costs, and preferred share capital costs.Funding, including debt cost, equity costs, cost of retained profits and share capital costs.
TerminologyThere is no such terminology of Cost of Capital.The Capital Structure is also known as WACC or the overall cost of capital.
ImportanceMaximizing the capital of owners.Showing the financial structure of a corporation is regarded as a proportion of short-term debt and long-term debt.

What is Cost of Capital?

The cost of maintaining funds received from different sources and used in industry is referred to as the capital cost of a company. Cost of capital is the capital framework that the business would receive to provide long-range financing for customers. Money arranges that a company would receive to draw funding suppliers to make the financing available to the company. With the benefit of the cost of capital, the goal of maximizing shareholders’ equity is accomplished.

The Cost of capital helps shape the business structure of the organization, evaluating potential investments and measuring financial results. A firm’s income is smaller, its investor risk is more serious, and if the cost of capital is high, the economic structure is imbalanced. The capital cost components apply to each funding source, including debt cost, equity costs, cost of retained profits, and share capital costs. For computing capital costs, there are various formulae.

What is Capital Structure?

The capital structure is the mix of a company’s debt and equity to fund its overall operations and expansion. Besides, Equity capital is extracted from a company’s shareholdings and claims its potential cash flows and earnings. Debt takes the form of bond issues or bonds, while equity can be capital, common stock, or retained profits. In the financial system, short-term debt is considered too.

The balance sheet contains both debt and equity. The securities of corporations are accumulated with this debt and equity and are also listed on the balances. The Capital Structure may be a combination of a company’s long-lasting debt, short-lasting debt, and common stock. An overview of the financial structure of a corporation is regarded as a proportion of short-term debt and long-term debt.

Main Differences Between Cost of Capital and Capital Structure

  1. The capital cost is the estimated investment capital structure, while the minimum return on investment is the desired capital structure.
  2. In the formulation of the capital structure, expenditure option assessments, and financial success assessments, the cost of capital is included. Capital structures, on the other hand, minimize investment risk and guarantees.
  3. The capital cost elements are: interest costs, equity costs, retained income costs, and share the capital cost of choice. In contrast, the WACC components are weighted capital cost components.
  4. The Capital Structure is referred to as the required capital structure or WACC. Cost of capital, on the other hand, has no replacement word.
  5. Cost of capital allows owners to optimize equity, whereas the capital structure helps to ensure stability.

Conclusion

Previous finances were seen as not a regular cup of tea by a man. Saving and potential deposits in government banks are the only preferred choice for future planning and savings. The ordinary man or working citizens in the middle class are fearful of buying shares, bonds, or the general stock market. Previously, several complex processes were not available to join and operate in the stock market because only a few important business actors were involved. The value of spending and saving has needed years for people to recognize.

Any other citizen is involved in investing today. People learn new skills or employ experts to spend money in the right way. The two critical aspects of financial management include capital cost and capital structure. Therefore, investing on your own or employing a consultant necessitates information on both.

References

  1. https://www.jstor.org/stable/1809766
  2. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1745-6622.1999.tb00027.x