Debt Vs. Equity Financing Paper Essay Example | Topics and Well Written Essays - 750 words

Debt Vs. Equity Financing Paper - Essay Example On the other hand the process of issuing stock so as to raise capital for a firm is called â€Å"equity financing†. This is a study set out to discuss these two sources of financing for a firm and eventually choose the better alternative depending upon the merits and demerits associated with either. To achieve this, these will be a vivid answer to the question, â€Å"which are the differences between debt financing and equity financing and which alternative is preferable to the other?† (Livingstone and Grossman, 2001) Debt financing refers to the money borrowing from a source outside the business and this is accompanied with a promise to repay the principal together with the interest agreed upon by the parties. Start up as well as established companies usually turn to this source of financing to fund their operations. In the context of finance, a debt is also known as leverage. Examples of places or sources from which businesses can get debt finance may include banks and other sources like issuing by a private company or friends. Merits associated with debt finance are several. Firstly, debt financing helps a company maintain the ownership structure. That is, when a business borrows from a bank it is only obliged to pay principal and interest on time and that is the end of such an obligation. Secondly, its principal as well as interest are put in the profit and loss account of a business as expenses and this helps by deducting from the company the associated income taxes. (Richards, 2009) However, this funding source is disadvantageous to a business. The interest payments going with the debt increase the break-even point of a business. Also, the higher a company’s leverage or debt-to equity ratio the chances of securing credit from a lender. A debt can also restrict the actions of the management of a company in that owners of the firm are obliged to personally guarantee loans and thus may be called for to secure repayment by pledging