Capital structure, also referred to as a company’s debt-to-equity ratio, describes the amount of debt compared to the amount of equity a company chooses to fund its operations and growth. A company’s debt may include bonds, and short- and long-term loans. Equity is generated from the sale of common and preferred stock and may also include retained earnings from previous periods. While many factors come into play when considering a company’s capital structure, as the debt-to-equity ratio increases, the company is generally considered to be more risky. But in today’s business environment, debt is usually cheaper than equity, meaning that increasing equity results in a higher cost of funding capital needs.
In the case of a regulated utility company, its capital structure is approved by the regulatory commission with jurisdiction over the utility. This is because the capital structure will impact customer rates as well as the risk profile of the utility. Typical capital structures for regulated utilities in the U.S. are in the range of 40% debt to 60% equity and 60% debt to 40% equity.