Question

i am currently studying long-term liabilities and am confused between the equity financing and bond financing.

what are the pros and cons of each financing?

Answer 1

Equity Financing :

Equity Financing means raising the capital or finance from the stockholders, to whom we give the right in the company's net profit for the amount they have given. The Equity finance has an various advantages which includes:

1. No Repayment Burden : In Equity Financing, there is no fixed repayment schedule to repay the amount raised from the stockholders. So, the company can focus on earning without worrying about the repayment.

2. Flexibility : It provides the flexibility to pay the return to the investors only when the company has the money. Since, there is no fixed annual payment, they can pay if the company management decides to pay the stockholders' in the form of dividend.

It has also disadvantages which are as follows:

1. Higher Cost : Even though, there is no fixed repayment, but the payment when made to the stockholders' is more than the amount paid towards debt. It takes away a part portion of profits unlike a fixed percentage.

2. Fund Raising : Raising Funds from Investors takes more time and more inital cost. This requires a lot of effort in terms of time and cost.

3. Loss of Control : In Equity Financing, there is a loss of control because it gives away the ownership to the investors. which also requires the approval from all or majority of them in taking decisions.

Debt Financing :

Debt Financing means taking a loan or raising the money from the issuance of bonds which involve the fixed monthly or annual payment.

The Advantages of Debt Financing includes :

1. Expenses / Cost known in Advance : If the financing is raised through debt, the cost outflows in future will be known in advance which will help in estimation of cash flows and Budgets.

2. Retention of Control and Ownership : Financing through debt helps the owner retain his control over the company and can make his decisions without having the influence of the others. However, he has to take the decisions which are good for the company as a whole.

3. Time and Effort : Raising the Funds through Debt Financing is a lot easier and time saving than raising the funds through equity.

The Disadvantages of Debt Financing includes :

1. Fixed Payment : It includes the Fixed Repayment, which means it has to pay even when it incurs losses and the business is not well. If there is any economic instability, the debt financers require their money back.

2. Can not take Risk : They will not bear the risk if there is a chance that the money invested will be lost. Whereas the equity holders place their risk and can not take the money back from the business.

Conclusion : Both Equity or Debt Financing has advantages and Disadvantages. But it to be taken care that the company maintains the adequate debt - equity ratio so that the company can run smooth. Promoters has to plan and take the appropriate decision.