Financing is the provision of funds to finance business activities, purchases or investment. Finance institution and banks are the major institutions involved in financing because majority of their activities are targeted towards the provision of business capital to consumers and investors for the attainment of their goals. Financing is very important to any economic system due to the fact that it gives room for companies to make purchases on products ordinarily out of their reach.
There is financing made available for individuals and there is financing made available for companies. Basically, we have two types of financing for companies namely; debt and equity financing. A debt is compulsorily paid back, but is most times a cheaper method of raising capital because of its tax considerations.
Equity on the other hand does not need to be paid back, but it transfers ownership to the shareholder. Both types of finance have their benefits and consequences. A lot of companies endeavor to make use of both types of financing.
Types of Finance
- Equity Financing
- Debt Financing
Equity is another word used to describe ownership, If the owner of a store requires the expansion of his/her store activities and operations without any form of debt, he would be more open to selling a 10% stake of his business for a certain amount. Companies prefer the use of equity due to the fact that the company bears no liability for equity, meaning all the risk is borne by the investor.
It is also important to note that, relinquishing equity is the same as relinquishing control. Investors in equity want to have a role in the running of the company during turbulent seasons. In order to gain ownership, an investor provides capital for a company in exchange for a claim on the company’s future earnings.
Investors have different targets when investing in a company, some require growth in form of the rising of share prices. Other investors are however looking for a protection of their investment (the principal) and income such as regular dividends.
A lot of people have a broad knowledge on debt as a form of financing due to their experience with loans and mortgages. Debt is another type of financing for new businesses. Financing as a result of debt must be given back to the investor.
During repayments, some lenders require that they are paid a percentage of the capital invested as interest for the use of their money. Other lenders require collateral. For example, if the owner of the store decides he/she need a delivery truck and must get a loan worth $20,000. The delivery truck can serve as collateral for the loan and the store owner may agree to pay 5% interest to the lender till the loan is paid off at an agreed time. Debt is preferable to obtain for the purchase of certain assets requiring smaller amounts of money, more importantly if the asset can serve as a form of collateral.