When starting a business an important question arises, how to finance the company. The steady economic growth combined with low interest rates has produced a lot of liquidity in debt and equity markets. For example, in 2005, non-financial corporate business borrowing increased dramatically to $289 billion, compared to the mere $174 billion it was in 2004 and the $85 billion it was in 2003 (Chung). The outcome of using only debt financing or only equity financing is mostly direct. Businesses run ino the issue when a company’s finance requires both debt and equity characteristics, changing the tax effects greatly (Hanke). Thesis: Businesses deem financing necessary when they are just beginning, expanding, or recovering; Debt financing and equity financning have many advantages and disadvantages but also change the entire accounting method that is to be considered while running the business. Debt financing has both advantages and disadvantages. Debt financing is a business’ way to start up, expand, or recover by borrowing money from a preson or company. The money borrowed has to be paid back along with the interest that was accrued during the length of time the loan was carried out. This option is great for company’s that do not want investors. Debt financing is beneficial because the loaners do not often get involved with the company or any decision making within the company. The downfall is the risk that is assumed with the debt which is, the company may not be able to pay back the loaner. In that case, the loaner would go after the owner or partner personally. There are many forms of debt a company is allowed to take on, such as ‘venture’ debt, even if they are a high-risk corporation. ‘Venture’ debt is a form of senior debt ... ... middle of paper ... ...es almost zero involvement by the loaner. Equity financing is an exchange of an asset for stock between owner or partner and investor. A repayment is not required but involvement of the investor is which has some benefits and only a few drawbacks. Depending on which option the company chooses to use, the accounting can be different in a few different ways. Equity requires capital contributions and dividends to be distributed while debt financing requires note receivables, note payables, and any accrued interest. Companies have more options than before; the small, medium and big corporations. Businesses usually fiannce when expanding, recovering, or starting up; Debt financing and equity financing both have many advantages and disadvantages along with a variance in accounting methods that should be considered when a business is attempting to make a finance decision.
Equity capital represents money put up and owned by shareholders. This money can be used to fund projects and other opportunities under the auspice of creating greater value. This type of capital is typically the most expensive. In order to attract investors, the firms expected returns must consummate with the associated risk ("Financial leverage and,"). To illustrate this, consider a speculative oil drilling operation, this type of operation would require higher promised returns than say a Wal-Mart in order to attract investors. The two primary forms of equity capital are 1) money invested into the business for an ownership stake (i.e. stock) and 2) retained earnings from past profits used to fund future growth through acquisitions, expansions and product development.
The consistent high spending of capital equipment is the first reason why one would recommend reducing the debt to equity ratio. A company with higher levels of debt is less flexible in being able to adjust to new market demands and conditions that require the company to make new products or respond to competition. Looking at the pecking order of financing, issuing new shares to fund capital investing is the last resort and a company that has high levels of debt, must move to the equity side to avoid the risk of bankruptcy. Defaulting on loans occur when increased costs or bad economic conditions lead the firm to have lower net income than the payments on loans. The risk of defaulting on loans and the direct and indirect cost related to defaulting lead firms to prefer lower levels of debt. The financial distress caused by additional leverage can lead to lower cash flows available to all investors, lower than if the firm was financed by equity only. Additionally, the high debt ratio that Du Pont incurred also led to them dropping from a AAA bond rating to a AA bond Rating. Although the likelihood of not being able to acquire loans would be minimal, there are increased interest costs with having a lower bond rating. The lower bond rating signals to investors that the firm is more likely to default than if it had a higher (AAA) bond rating.
There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an optimal capital structure by using a mixture debt and equity known to act as an advantage leverage. Modigliani and Miller (1958) showed that the decisions firms make when choosing between debt and equity financing has no material effects on the value of the firm or on the cost or availability of capital. They assumed perfect and frictionless capital markets, in which financial innovation would quickly extinguish any deviation from their predicted equilibrium.
There is a range of criteria relevant for a decision of financing a new venture. To construct my list for the evaluation of a new company as an opportunity I have selected to refer to t...
There are two basic ways of financing for a business: Debt financing and equity financing. Debt financing is defined as 'borrowing money that is to be repaid over a period of time, usually with interest" (Financing Basics, 1). The lender does not gain any ownership in the business that is borrowing. Equity financing is described as "an exchange of money for a share of business ownership" (Financing Basics, 1). This form of financing allows the business to obtain funds without having to repay a specific amount of money at any particular time. There are also a few different instruments that could be defined as either debt or equity. One such instrument is stock options that an employee can exercise after so many years with the company. Either using the debt or equity method, or a combination of the two methods can be used to account for stock options or other instruments with the similar characteristics.
Adelman, P. J., & Marks, A. M. (2010). Entrepreneurial finance. (5 ed.). Bedford, Texas: Prentice Hall.
Financial distress which results in bankruptcy are very common for businesses in today’s economy. According to CNN Money Fortune 500, “Last year marked the highest number of billon-dollar bankruptcies ever recorded. And corporate bankruptcies have continued at an elevated clip, with about twice the number of businesses filing for bankruptcies filing for bankruptcy protection in the 12 months ending June 2010, as they did during the same span of time in 2008, 2007, or 2006.” (Roane, 2010) It is very important for every financial manager to acknowledge that bankruptcy can be a reality for any company and financial managers have to know how to prevent it. Most all companies have debts and these debts are used for financial leverage, but they have to be closely monitored by the financial manager. Many monthly debts that companies are faced with are, making monthly payments to vendors, and paying employees. It is the financial managers to manage and monitor these debts, so that the debts don’t become more than the equity. (Ross, Westerfield, & Jordan, 2010)
All business activities require finance to establish itself physically in a location and to fund daily activities of the business. This money can be acquired in two ...
Some banks may require the firm to maintain a balance between debt and equity which is suitable in the industry and the state of the business is working (Melicher, Welshans, and Wel.., 2011). Jackson preferred the use debit financing by borrowing loans from bank to boast its business operations. Jackson Company was in pursuit of aggressive development plan thus prompting
Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
If you are looking to finance your business with equity, you should understand the disadvantages. Adding a professional investor on board always comes at a cost in the ownership of your business. The more money you raise like this, the less ownership you have over your own business.
Bank loans are loans from the bank which is based on the future value of the business. Banks are very particular when it comes to granting loans because they want to be sure that the borrower will be able to repay. In some situations, if the loan is not repaid to bank can take possession of the borrower’s personal assets. Even though the bank pays for the business, they do not take possession of the establishment. Figuratively, when Joe Smith pays off the loan, he doe not have any more ties with the bank, unless he asks for a subsequent loan. A precaution that must be taken when requesting a loan is the cost of bank loans. Interest rates are very high and must be paid regardless of if the specific business became successful. This is a huge risk that new business owners, who decide to take out a loans, have to take. Borrowers receive tax deductibles which makes it easy for businesses to make monthly loans payments and keep up with interest rates.
The capital structure of a firm is the way in which it decides to finance its operations from various funds, comprising debt, such as bonds and outstanding loans, and equity, including stock and retained earnings. In the long term, firms seek to find the optimal debt-equity ratio. This essay will explore the advantages and disadvantages of different capital structure mixes, and consider whether this has any relevance to firm value in theory and in reality.
Maintaining a company’s financial assets is a daunting task. Cash management techniques and short-term financing provide accounting executives with the tools needed to survive the constant changes within the economy. The combination of these tools and the knowledge of the world economy will assist companies in maintaining current assets and facilitates growth.
Smaller companies are much more likely to obtain an attentive audience with a commercial loan officer after the start-up phase has been completed. In determining whether to extend debt financing--essentially, make a loan--bankers look first at general credit rating, collateral and your ability to repay. Bankers also closely examine the nature of your business, your management team, competition, industry trends and the way you plan to use the proceeds. A well-drafted loan proposal and business plan will go a long way in demonstrating your company's creditworthiness to the prospective lender.