Finance

Debt Financing vs Equity Financing

Debts are funds that can be refundable while equity cannot be refunded.

What does Financing mean?

Financing is the act and way of providing and sourcing funds and money for starting or running a business. It can also be defined as the act of providing capital for business. Capital can be any durable goods or money or wealth that can be used to start a business. Financing takes two ways which are Debt Financing and Equity Financing.

Debt Financing vs Equity Financing –

Debts are funds that can be refundable while equity cannot be refunded but rather takes a path in which funds or capital are distributed into a business or corporations by shareholders for the purpose of getting a maximum profit when the corporation increases in value.

Debt Financing

Debt Financing is one of the most familiar methods of sourcing funds to run or start a business organization. Lenders must be paid back in the rate of interest for the exchange for the use of their money to start your business or running your business.

In Debt Financing, the debt must be repaid at an agreed and stipulated time. Most people are familiar with debt as everybody borrows or lends money or any other thing daily.

Some lenders collect their money in installments like in the case of car lenders. They provide a car and you pay them monthly installments till the amount for the vehicle is complete. These people gain more on the vehicle as the real amount or the worth of the car is passed as you provide them their installments daily or weekly or annually.

For example:- A Toyota vehicle that is worth $900,000 but was supposed to be sold at the rate of $1M, is been given out to a man in installments with the agreement of paying $40,000 monthly.

At the end of the year, if he is able to pay the money monthly, the money with the lender would be $1.2M which makes him have $200,000 apart from the profit which he is supposed to have on the vehicle. The lender also uses the over profit acquired for Financing the business by trying to get more cars.

Equity Financing

Equity Financing gives everyone equal right in the business. Investors buy shares from a company and wait for the company to increase in value and they have their profits for the investments. The reward is called dividends. They all run the affairs of the corporation together or they have someone in charge of the business on their behalf. To start an Equity Financing, a business owner might decide to sell 10% of the business stocks to investors for the purpose of using the money for Financing the Business.

The investors might get nothing if the business does not yield any profit. The investor gets his own share of the profit to the company as dividends if the company has yielded and also increases in value. In companies that have Equity Financing, the investors bear all the risk.

READ: What is Beta meaning in Finance

An investor always wants to have his opinion known in the corporation. In return, operates the corporation together with the original owner of the business. He claims some percentage of the future earnings of the company.

Capital Budget of Company

Some businesses try financing their company in both Debt and Equity. Capital budgeting is usually put in place to know the cost of capital. Cost of capital is the necessary and required amount of money or funds or capital that are necessary for capital budgeting in financing a business. Some company runs their business basically on debts while some on equity and some practice both. They sell their shares to investors and at the same time take loans from external sources. In the end, when the profit is yield, the debt will be paid as it’s a liability. From this, the net worth of the company is known. The investors share the money according to the percentage of shares bought from the company.

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Harish Yadav

Finance and market analyst and chief writer on howtofinance. Passionate to read books and articles on marketing and accounting. Also edits other articles and publish them here.

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