Capital structure refers to the composition of the "Shareholder Equity and Liabilities" section of a

corporation's balance sheet. Capital budgeting, on the other hand, refers to the process of
evaluating investment prospects. Capital structure and capital budgeting must be aligned to
ensure that the business has sufficient cash to undertake the investments necessary. A failure to
match cash needs to cash sources spells disaster for any business and, in extreme cases, can
result even in bankruptcy.

Capital Budgeting
Capital budgeting is the process of evaluating a prospective investment from a financial
perspective. During the capital budgeting process, the CFO, or in a smaller company the business
owner, maps out the cash outlays and cash inflows associated with an investment. In the case of
building a new factory, for example, the cash outlays may be monthly expenses for the
construction, lasting two years. The cash inflows may then last for 10 years, resulting from the
sales proceeds of products to be manufactured in the facility, until a renovation is needed.
Companies use various tools when comparing cash inflows and outflows, including internal rate of
return, discounted cashflow analysis and payback period.

Capital Structure
Capital structure refers to how a business is financing its operations. It's quantified as the ratio of
net shareholder equity to total debt on the balance sheet. Regardless of the size and scope of a
business, all companies have access to the same two basic sources of funds: shareholders or
lenders. In other words, the source of funds on the balance sheet is either shareholder equity or
liabilities. Retained earnings from a past period's profits also qualify as shareholder equity, since
these profits belong to shareholders. Liabilities encompass a wide variety of loans, including bank
loans, funds provided by bond investors and money owed to suppliers far past purchases.