Debt versus Equity Financing Paper ACC/400 Debt versus Equity Financing Equity along with debt financing, are types of financing. The financial strength should be every organization’s main concern when looking for capital. The more capital the organization has invested in its business the easier it is to obtain financing. An organization should increase stockholder capital for additional capital, if it has a high portion of debt to equity, so that it does not overextend itself and risk the business going under. What is Debt Financing?
Debt financing is defined borrowing capital from external investors with an agreement to pay back with interest at a certain time. Debentures are custom in raising additional funding (debt offering) for organizational operations or expenditures. Organizations are in debt to stockholders until the bond matures. Moreover, debt is found in the organization’s balance sheet. Organizations choose to raise additional capital by the debentures and not have to use company assets or give up a percentage of ownership in the company.
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Debt financing is riskier than equity financing because debt must be repaid at a certain time no matter how if the organization is profitable or not. In addition, organizations must be careful in how much debt it takes on – no matter what type or amount. What is Equity Financing? Equity financing is another way an organization can raise additional capital (by issuing common and preferred stock). Investors, who purchase stock, are buying a share of ownership in the organization.
Common stock entitles stockholders to a share of ownership, along with dividends. Preferred stock represents equity ownership too; but with no voting rights; however, it does have priority over common stockholders claims. Alternative Capital Structure The goal of any capital structure is to reduce cost of capital. The cost of debt is cheaper than equity. However, too much debt increases financial risk. Furthermore, obtaining the appropriate blend of debt and equity to achieve the best capital structure is important to a company.
Organizational capital raised by selling stock is good; however, the organization must give up a portion of ownership. Organizational capital raised by debt financing causes the organization to pay interest to the bondholder at a set-date. Unlike common stockholders, bondholders are not entitled to ownership interest in the organization. Depending, on the organization’s current level of liabilities it has a choice (either debt or equity financing).
Disclosure of an organizations total capitalization – debt and equity – is summarized on the balance sheet as follows: * Assets – what the company owns: cash in the bank, accounts * Liabilities – what the company owes: accounts payable, short-term debt and other obligations * Equity – excess value of assets over the value of liabilities. Net worth of an organization is calculated by subtracting liabilities from total assets. The computation is as follows: Assets – Liabilities = Net Worth References
Debt Financing (2011), Retrieved June 18, 2011 from, http://www. businessfinance. com/debt financing. htm Debt vs. Equity Advantages and Disadvantages (2011), Received June 18, 2011 from, http://www. residual-rewards. com/debt-vs-equity. html Kimmel, P. , Weygandt, J. , & Kieso, D. (2007). Financial Accounting: Tools for Business Decision Making (4th ed. ). Hoboken, NJ: Wiley. Richards, Daniel (2011), Debt Financing Pros and Cons, Retrieved June 19, 2011 from, http://entrepreneurs. about. com/od/financing/a/debtfinancing. htm
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