Debt Financing and Equity Financing

Companies can sometimes fail to find their budgets due to several reasons including low cash flow. There are several ways in which companies can finance budget shortages. Debt financing and equity financing are two ways that will be looked at in this article. The two methods do help address cash flow issues, but they also have their benefits and drawbacks.

Debt Financing

Debt financing is basically borrowing money from external outlets such as banks and other financial institutions to cover cash flow budget shortfalls. Some of the advantages of debt financing include:

·         Fixed interest rates which provide stability in a company’s financial planning and budget.

·         Control over ownership: Debt financing does not dilute a company’s ownership which means shareholders retain dominance over the company.

·         Tax-deductible interest reduces a company’s overall financial cost.

However, debt financing carries with some disadvantages:

·         Default risk: If a company fails to meet its debt obligation, it can face penalties or even bankruptcy.

·         Limited Credit availability: A lender can only provide debts basing on a company’s creditworthiness. Some lenders may also need collateral or offer high interest rates.

Equity Financing

Equity financing entails accumulating funds through selling of shares in the company to investors. Its advantages include:

·         There are no interest payments.

·         There is no repayment obligation.

·         There is increased credibility.

Equity financing has some disadvantages which include:

·         There is loss of control since as more shares are sold, ownership becomes fragmented.

·         Equity financing involves selling ownership shares in the company, which can dilute the ownership stake of existing shareholders.

·         Equity financing often involves high costs of capital, as investors will expect a higher rate of return on their investment than lenders.

In conclusion, debt financing and equity financing are options that have their benefits and disadvantages. Companies need to scrutinize and evaluate keenly their cash flow needs and financial goals before deciding which method to use to finance their cash flow budget shortage.

References

"Advantages and Disadvantages of Equity Financing." Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/finance/advantages-disadvantages-equity-financing/

"Equity Financing: Advantages and Disadvantages." Investopedia. https://www.investopedia.com/terms/e/equityfinancing.asp

"Debt Financing: Pros and Cons." Investopedia. https://www.investopedia.com/terms/d/debtfinancing.asp

By Shem Kipkoech 1 year ago . Marked as helpful (170). Marked as unhelpful (180)