The capital structure of a business is the mixture of equity and debt it uses to finance its operations. The optimum capital structure is one which minimizes the weighted average cost of capital and thereby maximizes the valuation of the business.
Debt financing is one method of funding a business. The cost of debt financing is the interest and fees paid on the debt which are usually allowable for tax purposes. For this reason, the aftertax cost of debt financing is normally cheaper than the cost of equity financing.
A small business will purchase long term assets (fixed assets) such as plant, machinery, fixtures, vehicles, and computers for use within it’s operations. With the exception of possibly land, all these long term assets have a limited life span due to wear and tear and obsolescence.
Depreciation is the name given to the expense charged to the income statement each accounting period to represent the reduction in value of these long term assets. The purpose of depreciation is to set aside an amount of profit to replace the asset in the future.