FINANCING THE BUSINESS

Financing the Business

Financing the Business

Capital Structure

Debt financing and equity financing are the two major types of financing for a business. Debt financing is a type of financing facility, in which a company obtains a loan from a bank or any other financial institution (Davey & John, 1982, pp 238 - 249). While, equity financing is a type of financing, in which the company obtains the funds from the outside investors through issuing stock, common stock, or preferred stock. The main advantage of debt financing is the fact it will finish in the future, the company's obligation is only until the time, when the loan is on the company the moment the company pays off the loan, and their obligation is over. Another huge advantage of debt financing is the tax shield that comes with debt financing (Ross, Westerfield & Jordan, 2002, pp 137 - 141). However, the disadvantage of debt financing is that it increases the risk of the company, because there is always a chance of default from any company. Another drawback is the interest factor; the company has to pay interest on the debt on a regular basis (Guilding, 2002, pp 64 - 87).

The advantage of the equity financing is that there is no obligation to pay any fixed amount on a regular basis; the company can pay anytime to the investors. However, the disadvantage of equity financing is the lack of tax shield (Ross, Westerfield & Jordan, 2002, pp 137 - 141).

The decision by a company, whether to go for debt financing or equity financing depends on the risk orientation of the company. A company with strong financial background would go for debt financing, because they can bargain with creditors on the interest rate. Otherwise, the company would go for equity financing because of the lack of any obligation to pay a specific amount after a decided interval of time (Corsepius, Nunnenkamp & Schweickert, 1989, pp 120 - 131).

Over the past years, the trend of debt Vs Equity financing has been almost the same. The organizations, which are operating on a larger scale mostly, prefer to go for debt financing. The reason behind this trend is the tax shield, which comes with debt financing, and their ability to obtain loans at an interest rate, which is beneficial for them (Kothare, 1992, pp 189 - 196).

I would recommend debt financing for the companies, which have strong financial base and strong cash flows, especially the operating cash flows. This would enable them to obtain a loan at much lower interest rates, and then the tax shield would be there, this would help them in maximizing their profits. However, for a small company, I would recommend equity financing, because it is always difficult for a small company to obtain funds at a cost, which would suit them.

Types of investment Appraisal techniques

Payback period technique

It calculates the time consumed by the project to get back the initial ...