- Learn Basic Accounting in Less than 1 Hour!
- Accounting Basics
- What are Accounting Principles
- Accounting Cycle
- Accrual Accounting Basis
- Cash Basis Accounting
- Matching Principle of Accounting
- Conservatism Principle of Accounting
- Revenue Recognition Principle
- Prudence Concept in Accounting
- Cash Accounting
- What are Accounting Policies?
- Relevance in Accounting
- Accounting Estimates
- Mark to Market Accounting
- Prior Period Adjustments
- Cash Accounting vs Accrual Accounting
- Break Even Point In Accounting
- Operating Cycle
- Fiscal Year
- Fiscal Year vs Calendar Year | Top Differences | Examples |
- Financial Reporting
- Financial Statements
- Accrual vs Provision
- Accrual vs Deferral
- Temporal Method
- Interim Financial Statements
- Pro Forma Financial Statements
- Consolidated Financial Statement
- Audited Financial Statements
- Financial Statement Audit
- Internal Audit vs External Audit
- Interim Reporting
- Accounting Scandals
- Quality of Earnings
- Audit Risk
- Sunk Cost
- Leasehold vs Freehold
- IFRS vs US GAAP
- IFRS vs Indian GAAP
- Accounting for Fair Value Hedges
- Debit vs Credit in Accounting
- Single Entry System in Accounting
- Double Entry Accounting System
- Journal in Accounting
- Adjusting Entries in Journal
- General Journal
- Accounting Journal Entry
- Ledger in Accounting
- T Accounts
- Account Balance
- Journal vs Ledger
- General Journal vs General Ledger
- What is Trial Balance ? | Examples | Steps | Prepare | Errors
- Nominal Account
- Adjusted Trial Balance
- Reconciliation of Books | Types, Best Practices | Useful Tips
- Petty Cash | Meaning | Template | Accounting | Example
- Petty Cash Book
- Debit Note | Debit Notes Accounting & its Top Characteristics
- Credit Note
- Debit Note vs Credit Note | Top 7 Differences (Infographics)
- Drawing Account
- Balance Sheet
- Balance Sheet
- Balance Sheet Purpose
- Capital Expenditure Formula
- Statement of Financial Position
- Accounting Equation
- Assets vs Liabilities | Top 9 Differences (with Infographics)
- Equity vs Assets
- Trial Balance vs Balance Sheet | Top 10 Differences You Must Know!
- Balance Sheet vs Consolidated Balance Sheet
- Bank vs Company Balance Sheet
- Banks Balance Sheet
- Commitments and Contingencies
- Management Discussion & Analysis
- Revenue Reserve vs Capital Reserve | Top 7 Differences
- Revenue Reserve
- Capital Reserve
- Capital Receipts vs Revenue Receipts | Top 8 Differences
- Capital Lease vs Operating Lease | Top Differences You Must Know!
- Debt vs Equity Financing | Advantages | Disadvantages | Example
- Internal vs External Financing | Top 7 Differences (Infographics)
- Available for Sale for securities
- Held to Maturity to securities
- Non-Performing Assets (NPA)
- Cash and Cash Equivalents | Examples, List & Top Differences
- Cash Equivalents
- Restricted Cash
- 3 Types of Inventory | Raw Material | WIP | Finished Goods
- Ending Inventory Formula
- Average Inventory Formula
- Closing Stock
- Inventory vs Stock
- Current Assets
- FIFO vs LIFO
- First In First Out (FIFO)
- Last in First Out (LIFO)
- LIFO Reserve
- Non-Current Assets
- Accounts Receivables? | Definition, Accounting Examples
- Accounts Receivables Factoring
- Trade Receivables
- Net Realizable Value (NRV)
- Allowance for Doubtful Accounts
- Accrued Revenue
- Liquid Assets
- Quick Assets
- Marketable Securities on the Balance Sheet | Top Examples
- Trading Securities in Balance Sheet
- Prepaid Expenses
- Prepaid Insurance
- Tangible vs Intangible Assets
- Tangible vs Intangible
- Contingent Asset
- Tangible Assets
- Deferred Tax Assets
- Capital Expenditure (Capex)
- Capex vs Opex
- Salvage Value
- Residual Value
- Fixed Capital vs Working Capital | Top 8 Differences (Infographics)
- Impariment of Assets
- Negative Goodwill
- Goodwill Valuation
- Capitalized Interest
- Accounts Payable | Days Payable Outstanding | Formula |
- Current Liabilities | List of Current Liabilities on Balance Sheet
- Accrued Liabilities
- Accrued Interest
- Notes Payable
- Accounts Payable vs Notes Payable
- Revolving Credit Facilities
- Bonds Payable Accounting
- Bad Debt Reserve Allowance
- Deferred Expenses
- Deferred Tax Liabilities
- Unearned Revenue (Sales)
- Deferred Revenue (Income)
- Current Portion of Long-Term Debt (CPLTD) | Balance Sheet
- Long-Term Debt in Balance Sheet
- Financial Liabilities | Definition, Types, Ratios, Examples
- Long-Term Liabilities
- Accounts Receivable vs Accounts Payable
- Minority Interest
- Accounting for Convertibles
- Accounting for Derivatives
- Financial Lease vs Operating Lease
- Off balance Sheet Financing
- Finance vs Lease
- Bond vs Loan
- Triple Net Lease
- Debtor vs Creditor
- Shareholders Equity
- Shareholders Equity Statement
- Negative Shareholders Equity
- Par Value of Stock
- Share Capital
- Outstanding Shares (Definition, Formula) | Stocks Outstanding
- Additional Paid-in Capital on Balance Sheet
- Retained Earnings (Formula, Examples) | How to Calculate?
- Retained Earnings Formula
- Statement of Retained Earnings
- Appropriated Retained Earnings
- Unappropriated Retained Earnings
- How to Calculate Net Worth of a Company | Formula | Top Examples
- Owners Equity
- Preferred Shares
- Non-Cumulative Preference Shares
- Participating Preferred Stock
- Weighted average Shares average outstanding
- Share Buyback
- Accelerated Share Repurchase
- Restricted Stocks Units (RSUs)
- Contingent Shares
- Stock Splits Share
- Treasury Stock Shares
- Dilutive Securities
- Anti Dilutive Securities
- Stock Dividend
- Cash Dividend
- Final Dividend
- Preferred Dividends
- Homemade Dividends
- Ex dividend date
- Date of Record of dividends
- Qualified vs Ordinary Dividend
- Wealth vs Profit Maximization
- Cost of preferred Stock
- Common Stock vs Preferred Stock | Top 8 Differences You Must Know
- Stocks Vs Shares
- Stock Options Vs RSU
- Shareholder Equity vs Net Worth | Top 5 Differences You Must Know!
- Stock vs Option
- Stock vs Mutual Funds
- Income Statement
- Income Statement | Top Examples | Template | Format | Analysis
- Variable Costing Income Statement
- Pro Forma Income Statement
- Purpose of Income Statement
- Cost of Goods Sold
- COGS Formula
- Average Total Cost Formula
- Gross Profit
- Direct Costs
- Indirect Costs
- Prime Cost
- Duty vs Tariff
- Net Income Formula
- EBITDA Formula
- Operating Expense (OPEX)
- Interest Expense
- LTM EBITDA
- Non Recurring Items
- EBIT vs EBITDA | Top Differences | Examples | Calculation
- Depreciation – Formula | Types | Most Comprehensive Guide
- Depreciation Tax Shield
- Accelerated Depreciation
- EBITDA vs Operating Income
- Straight Line Depreciation Method
- Sum of Year Digits Method of Depreciation
- Declining Balance Method of Depreciation
- Land Depreciation
- Double Declining Balance Method
- Amortization of Intangible Assets
- Depreciation vs Amortization
- Unrealized Gains (Losses)
- Non Cash Expense
- Accrued Income
- Share based compensation
- Restructuring Cost
- Extraordinary Items
- Interest Income
- Double Taxation
- Net Loss
- Pro-Forma Earnings
- Margin vs Profit
- Net Operating Loss (NOL)
- Tax Shield
- Sundry Expenses
- Trade Discount
- Percentage of Completion Method
- Interest vs Dividend | Top 9 Differences (with Infographics)
- EBITDA vs Net Income
- EBIT vs Net Income
- EBIT vs Operating Income
- Operating Income vs Net Income
- Cost vs Expense
- Expense vs Expenditure
- Accounting Profit vs Economic Profit
- Income Tax vs Payroll Tax
- Tax credits vs Tax deductions
- Tax Evasion vs Tax Avoidance
- Regressive Tax
- Gross Income vs Net Income
- Profit vs Revenue
- Revenue vs Earnings
- Revenue vs Net Income
- Revenue vs Income
- Profit vs Income
- Revenue vs Sales
- Revenue vs Turnover
- Capitalization vs Expensing
- Income Statement vs Balance Sheet | Top 5 Differences You Must Know!
- Statement of Comprehensive Income | Items | Colgate Example
- Variance Analysis
- Other Comprehensive Income
- Partial Income Statement
- Income Summary Account
- FOB Destination
- Explicit Cost
- Implicit Cost
- Direct cost vs Indirect Cost
- Fixed cost vs Variable cost
- Price vs Cost
- Hard Cost vs Soft Cost
- Period Cost vs Product Cost
- Overhead Costs
- Nopat vs Net Income
- Marginal Costing vs Absorption Costing
- Marginal Cost Formula
- Margin vs Markup
- Markup Formula
- Contribution Margin vs Gross Margin
- Cash Flow Statement
- Statement of Cash Flow
- Cash flow from Operations | Formula, Calculations & Examples
- Operating Cash Flow Formula
- Cash Flow from Investing Activities (Formula & Top Examples)
- Cash Flow From Financing Activities | Formula & Calculations
- Cash Flow Analysis
- Pro Forma Cash Flow Statement
- Fund Flow Statement
- FFO (Funds from Operations)
- Direct vs Indirect Cash Flow Methods
- Cash flow vs Net Income | Key Differences & Top Examples
- Cash Flow vs Fund Flow | Top 8 Differences (with Infographics)
- Accounting Careers
- Accounting Interview Questions
- Financial Accounting Careers
- Top Accounting Firms
- Big Four Accounting Firms
- Forensic Accounting
- Cost Accounting
- Financial Accounting
- Accounting vs Engineering
- Finance vs Accounting
- Bookkeeping vs Accounting
- Accounting vs Auditing
- Accountant vs Actuary
- Bookkeepers vs Accountants
- Accounting vs Financial Management
- Cost Accounting vs Financial Accounting
- Cost Accounting vs Management Accounting
- Financial Accounting vs Management Accounting
- Public vs Private Accounting
- Accounting vs CPA
- Controller vs Comptroller
- Personal Banker Job Description
- Accounting Firms in Australia
- Accounting Firms in Canada
- Top Accounting Firms in US
- Accounting Firms in Singapore
- Accounting Books
Differences Between Debt and Equity Financing
Pepsi Debt to Equity was at around 0.50x in 2009-1010. however, it started rising rapidly and is at 2.792x currently. What does this mean for Pepsi? How did its Debt to Equity Ratio increase dramatically? What is the key difference between Debt vs Equity Financing? How does it affect the Financial Strength of the company?
Well, today let’s discuss financing your business what is right and why is it right for you – Debt vs Equity Financing. In this article, we discuss the following –
- What is Debt Financing?
- What is Equity Financing?
- Debt Financing – Advantages & Disadvantages
- Equity Financing – Advantages & Disadvantages
- Key Differences – Debt vs Equity Financing
- Analyzing Debt vs Equity Financing of Oil & Gas Companies (Exxon, Royal Dutch, BP & Chevron)
- Conclusion- Which to choose?
What is Debt Financing?
Debt means borrowing money, and debt financing mean borrowing money without giving away your ownership rights. Debts finance means having to pay both the interest and the principal at a certain date; however with strict conditions and agreements for the reason that if debt conditions are not met or are failed then there are severe consequences to face. Usually, the rate of interest and the maturity or the payback date of debt borrowings is fixed or pre-discussed. The payback of the principals can be done in full or in part payments as agreed upon in the loan agreement. Debt can be either a loan form or in the form of sale of bonds; however, they do not change the conditions of the borrowings the lender of the money can claim his money back as per the agreement. And hence lending money to a company is usually safe for you will defiantly get your principal back along with the agreed interest above the same.
Debt financing can be both secure and unsecured financing security is usually a guarantee or an assurance that the loan will be paid off, this security can be of any type; whereas some lenders will lend you money on the basis of your idea or on the goodwill of your name or your brand. Various types of security can be offered to avail a debt finance based on a security or debt finance can be availed as a different type of unsecured loans as well.
WallStreetMojo Free Accounting Course
You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!
* Please provide your correct email id. Login details for this Free course will be emailed to you
What is Equity Financing?
The company needs cash or additional cash to grow always. These funds can be raised either by debt or equity financing. Now that you know about debt financing let us explain equity financing. Unlike debt financing equity financing is a process of raising funds by selling the stocks of the company to the financer. Selling of stocks is giving ownership interest of the company to the financer. The proportion of ownership given to the financer depends on the amount invested in the company. Finance is required for every business and in every stage of business be it the startup or the growth of the company.
Equity financing is another word for ownership in a company. Usually, companies like equity financing because the investor bears all the risk in case of business failure the investor is also in a loss. However, the loss of equity is the loss of ownership because equity gives you a say in the operations of the company and mostly in the difficult times of the company. Besides just the ownership rights the investor also gets some claims of future profit in the company. Satisfaction of equity ownership comes in various forms for examples some investors are happy with the ownership rights, some are happy with the receipt of dividends, whereas some investors are happy with the appreciation of the share price of the company.
Also, look at Shareholders Equity
There are various reasons and requirements of investing in an organization. Look at the notes below to learn more.
Debt Financing – Advantages & Disadvantages
Debt Financing Advantages
- Debt financing does not give the lender ownership rights in your company. Your bank or your lending institution will not have a right of telling you how to run your company and hence that right will be all yours.
- Once you pay back the money your business relationship with the lender ends.
- The interest you pay on loans is after deduction of taxes.
- You can choose the duration of your loan it can either be long term or short term.
- If you choose a fixed rate plan you the amount of the principal and the interest will be known and hence you can plan your business budget accordingly.
Debt Financing Disadvantages
- You have to pay back the money in a specific amount of time
- Too much of loan or debt creates cash flow problems which create a trouble in paying back your debts.
- Showing too much of debt creates a problem in raising equity capital as debt is considered high-risk potential by investors and this will limit your ability to raise capital.
- Your business can fall into big crises in case of too much of debt especially during hard times when the sales of your organization fall down.
- The cost of repaying the loans is high and hence this can reduce the chances of growth for your company.
- Usually, the assets of a company are held collateral to the lending institution in order to get a loan as a security of repaying the loan.
Equity Financing – Advantages & Disadvantages
Equity Financing Advantage
- The risk here is less because it is not a loan and it need not be paid back. Equity financing is a very good way of financing your business if you cannot afford a loan.
- You actually collect a network of investors which increases you’re the credibility of your business.
- An investor does not expect immediate returns from his investment and hence it takes a long term view to your business.
- You will have to distribute profits and not pay off your loan payments.
- Equity financing gives you more cash in hand for expanding your business.
- In case business fails the money need not be repaid.
Equity Financing Disadvantages
- You can end up paying more returns than you might pay for a bank loan.
- You may or may not like giving up the control of your company in terms of ownership or share of profit percentage with investors.
- It is important to take the consent or consult your investors before taking a big or a routine decision and you may not agree with the decision given.
- In the case of a huge disagreement with the investors, you might have to only take your cash benefits and let the investors run your business without you.
- Finding the right investors for your business takes time and efforts.
Key Differences – Debt vs Equity Financing
|Sr. No.||The Base of Difference||Debt||Equity|
|1||Debt vs Equity Financing – Meaning||Funds borrowed from financiers without giving them ownership rights.||Funds raised by the company by giving the investor’s ownership rights.|
|2||What is it to the company?||Debt finance is a loan or a liability of the company.||Equity finance is an asset of the company or the companies own funds.|
|3.||What does it reflect?||Debt finance is an obligation to the company.||Equity finance gives the investor ownership rights.|
|4.||Debt vs Equity Financing – Duration||Debt finance is comparatively short term finance.||Equity, on the other hand, is long term finance for the company.|
|5.||What is the status of the lender?||Debt financier is a lender to the company.||The shareholder of the company is the owner of the company.|
|6.||Debt vs Equity Financing – Risk||Debt falls under low-risk investment.||Equity falls under high-risk investment.|
|7.||Types of financing||Debt financing can be categorized by Term Loan, Debentures, Bonds, etc||Equity can be categorized by Shares and Stocks.|
|8.||Debt vs Equity Financing – Investment Payoff||Lenders get paid interest over and above the principal amount financed.||Shareholders of the company get a dividend on the ratio of shares held / profit earned by the company.|
|9.||What is the nature of return?||The interest payable to the lenders is fixed and regular and also mandatory.||Dividend paid to the shareholders is variable, irregular as it completely depends on the profit earnings of the company.|
|10.||What is the security?||A security is required in order to secure your money, however, a number of companies raise funds even without giving a security||No security is requires in case of investing in a company as a shareholder as the shareholder get ownership rights.|
Analyzing Debt vs Equity Financing of Oil & Gas Companies (Exxon, Royal Dutch, BP & Chevron)
Below is the Capitalization ratio (Debt to Total Capital) graph of Exxon, Royal Dutch, BP and Chevron.
We note that Capitalization Ratio (Debt / Debt + Equity) has increased for most of the Oil & Gas companies. This means that company has been raised more and more debt over the years. It is primarily due to a slowdown in commodity (oil) prices affecting their core business leading to reduced cash flows and straining their balance sheet.
|Period||BP||Chevron||Royal Dutch||Exxon Mobil|
Important points to note here are as follows –
- Exxon capitalization ratio increased from 6.5% to 18.0% in a 3 year period.
- BP capitalization ratio increased from 28.4% to 35.1% in a 3 year period.
- Chevron capitalization ratio increased from 8.1% to 20.1% in a 3 year period.
- Royal Dutch capitalization ratio increased from 17.8% to 26.4% in a 3 year period.
Comparing Exxon with its peers, we note that Exxon Capitalization ratio is the best. Exxon has remained resilient in this down cycle and continues to generate strong cash flows because of its high-quality reserves and management execution.
Other articles that you may like
- Financing Acquisitions
- Cash Flow From Financing Activities
- Negative Shareholders Equity
- Market Capitalization
Debt vs Equity Financing Video
Conclusion- Which to choose – Debt vs Equity Financing?
When it comes to financing a company would choose debt financing over equity for it would not want to give away ownership rights to people it has the cash flow, the assets and the ability to pay off the debts. However, if the company really does not qualify in these above aspects of meeting up to the great risk of lenders they will prefer choosing equity finance over debt.
When you talk about an example we would always give you the example of a startup for a very simple reason and that is these companies have very limited assets to keep as a security with the lenders, they do not have a track record, they are not profitable and neither do they have cash flow and hence debt financing gets extremely risky. This is where equity financing steps in as investors can bear the risk for they are looking forward to huge returns if the company succeeds.
On the other hand, a company with too much of existing debts may not be able to get more loans or advances from the market. This is as good as being shorn of a mortgage loan for a simple reason that the banks cannot take the risk of funding a company with a weak cash flow, a poor credit history along with too much of existing debt. This is where the company should look for investors.
It is extremely important to strike a balance between the debt and equity ratios of a company to make sure you company makes appropriate profits. Too much of debt can lead to bankruptcy whereas too much of equity can weaken the existing shareholders and this can harm the returns. Hence the key is striking a balance between the two in order to maintain the capital structure of the company. Well, the ideal debt/equity ratio is 1:2 where equity always needs to be twice the debt of the organization. Double the quantity of equity is an assurance that the company can easily cover all the losses born by the company efficiently.
Like we all know it is extremely important to keep and maintain the balance of everything, the same goes with business and investments. Maintaining an appropriate balance between financing your company can lead you to appropriate profit making.