Question

All entrepreneurs need money in order to operate their firms. However, there are different methods for entrepreneurs to acquire money, including (a) debt (b) equity (c) family/friends. Explain these three types of financing and specifically compare and contrast them in terms of the entrepreneur’s need for control, financial returns, and the amount of money funded.

Answer 1

when any entrepreneur need money then he/she will have to evaluate the cost of amount of borrowing.this is considered as very crucial and sensitive matter in business operations.all the mentioned three financing activities have their own benefits and limitations.we can evaluate them as follow-

DEBT-debt is a kind of liability which may be secured or unsecured.debentures,bank loans and other borrowings are known as debt.

PROS-

• a certain rate of interest is provided at a predetermined date.
• the rate of borrowing is specified therefore the calculation is simple and concerned decisions can be undertake.

CONS-

• this rate of interest is irrespective of profit and loss,it means whether a firm is earning profit or incurring losses it would have to provide interest to the lenders.
• in case of recession period it would put more burden over the firm to pay the interest and worsen the condition of financial books of the company.

EQUITY-

equity generally represents the ownership of a company and furthermore when equity is distributed in small parts then it would be considered as shares.the holders of shares are called share holders.

PROS-

• the main advantage of equity is that it participates in profit and loss of the company.
• if the firm earns profit then shareholders would get dividend as a return and if firm incurs loss then the shareholders won't get any return.

CONS-

• if firm earns high rate of return then it would have to provide proportionate amount to shareholders and then the rate over borrowing would sometimes exceeds the rate of borrowing of debt.

BORROWINGS FROM FAMILY-

these are in general unsecured loans,but these have its own benefits and limitations-

PROS-

• generally no rate of interest or very low rate of interest.
• flexibility of return of the loan

CONS-

• due to sudden demand by the friends or family members the funds can't be utilized for the long term investment purpose.
• the dependency on the funds are very low.

now as we have studied the concept of these terms we can made following conclusions-

1. if the firm needs funds for long term purpose and firm is confident that the return generated would be high then it should go for DEBT facility.
2. if the firm needs funds for long term purpose and but firm is not sure about the return then it should go for equitites which would diversify its risk and it would help to expand the level of business.
3. if firm needs funds for short term then entrepreneur can avail the funds from friends and family.