The Differences Between Debt And Equity

When it comes to such things as expansion, research and development, or simply building a new manufacturing facility, organizations raise capital in a variety of ways, each with its own unique advantages and disadvantages. In this composition, an attempt will be made to compare and contrast the debt and equity markets, as well as state what type of investor might invest in each market.

In the business world, companies finance their operations, both short-term and long-term, in the following three ways: debt financing, equity financing, or profit accumulation. Simply said, profits are generated by a company from within, but debt and equity are external, and both are controlled by managerial decree. When it comes to comparisons, debt and equity financing also provide the required amounts of business capital and both involve investors, but here, the similarities generally end. Going forward, the differences between debt and equity funding will be discussed.

When attempting to raise capital, debt financing is where an organization obtains a loan or issues bonds to private or corporate investors. The fundamentals of debt financing are similar to household debt, familiar to just about everyone. For example, companies can arrange long-term financing to acquire equipment, plant facilities, or other long-term assets. This would be like a family taking out a loan to purchase a home or auto. A company can also use a form of revolving credit to pay for its short-term financial needs, such as inventory or payroll expense. A bond issue functions like a loan between investor and corporation. Investors give the corporation a designated sum of money in exchange for interest payments, usually on a semiannual basis. When the maturi...

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...want to make large sums of money because of those risks, and want to own a piece of the pie, or company. Investors who choose company bonds, desire a steady, low risk income, are satisfied with making less because of the minimal risk, and are not concerned with owning a part of the company. Choosing between debt and equity financing depends a lot on the company’s age and financial condition. Normally, start-up organizations with no history or positive cash flow choose equity financing. Companies that have been in business for a while, have a proven track record, good credit, and a positive cash flow, can go with debt financing and take advantage of the tax deductible interest expense. On the other hand, those same companies can choose equity financing, or a mixed version thereof. It all depends on corporate management, and the direction they want to take the company.