August 1, 2011
Debt is when one party, the debtor, owes to a second party, the creditor. This usually refers to assets owed but the term can also be used figuratively to cover moral obligations and other interactions not based on economic value. Debt is usually granted with expected repayment of the original sum plus interest.
The advantages of debt financing are that the company and/or individual can maintain control of the company and the interest on the debt is a tax deduction (Kimmel, Weygandt, Kieso, 2007). The disadvantage of debt financing that it can result in it becoming a crutch that is used to pay off the debt and too much of it will make the company look like a bad risk (Kimmel, Weygandt, Kieso, 2007). For example, when individuals or businesses purchase equipment to utilize during the day-to-day operations of the business, most of the time they have purchased them on credit and therefore they now have a debt that must be paid on a monthly basis. Equipment that is used during the daily operations of the business would include copiers, faxes, and even computers. Another of example of debt financing would be if the business was leasing their physical location (building) from a private owner and they have a lease that is paid monthly.
Equity financing involves an exchange between of financing between a lender and borrower usually with the offer of part ownership in the business. Some of the advantages of equity financing would include investors enable the business to become more credit worthy and repayment of financing is positive as long as the business is making money. A disadvantage of equity financing would be that the owner of the business would not be in complete control of the business since there are investors who have invested and have a say in how the business progresses. Some possible sources of equity
References: Capital Structure (2011). Reference for Business. Retrieved from http://www.referenceforbusiness.com Kimmel, P.D., Weygandt, J.J., & Kieso, D.E. (2007). Financial Accounting: Tools for Business Decision Making (4th ed.). Hoboken, NJ: John Wiley and Sons.