Debt financing refers to direct borrowing of money intending to repay the principal plus interest over a stipulated period whereas equity financing is the raising of money by stakes of a company to investors with the promise of sharing future profits of the company with the investors.
The second difference is that debt financing is received from lending organizations (creditors) whereas equity financiers become owners of the business entitled to dividends and other profits. Additionally, equity financing is usually long-term compared to debt financing that is relatively short-term in some cases. The last difference is that there’s a need for collateral in the case of debt financing whereas equity financing is collateral-free.
Sources of debt financing include tax-exempt government bonds, Federal Housing Administration (FHA)-insured mortgages, public taxable bonds, traditional mortgage financing, banks, insurance companies, and credit unions among others. On the other hand, the sources of equity financing include retained profits, philanthropic contributions, the public sale of company stock, venture capital companies, and partnerships (Cleverly & Cleverly 6).
Question 2: List of some of the pros and cons of retiring debt early.
Retiring debt early simply means paying the debt earlier than agreed. Its advantages include taking advantage of changes in the bond interest rates, paying less amount of interest on the loan, lowering one’s debt-to-credit ratio, and saving the monthly installments and using them to finance other projects (Cleverly & Cleverly 30). On the other hand, the demerits of early retirement of loans include losing out on the tax incentives received in the course of loan payments and some lenders charge penalties for early repayment of loans to recover for their lost interest.
Question 3. Explain the factors that influence the desirability of alternative sources of financing.
These factors are reasons that drive businesses to borrow money. The first factor is the need to take advantage of an unexpected opportunity. For instance, a business may want to acquire another company on short notice because they receive a good offer for it. Since they may not have ready cash, they will borrow money to finance this venture. Secondly, a business may desire to borrow money to purchase machinery and equipment that is critical for its business’ continuity. This need may be caused by a breakdown or change in business operations within the industry making it an urgent need for business.
Thirdly, businesses may also need financing for growth and expansion of businesses both locally and internationally. Globalization has made it possible for companies to expand abroad which is quite costly. Thus, businesses may seek additional financing to accomplish such strategic goals (Commonwealth of Australia, 2019). Fourthly, businesses may also seek financing during liquidity challenges especially in cases where they lack the cash to fund their daily financial obligations. Furthermore, a business may also need funding to purchase new stock required to be able to fulfill the clients’ needs for products. Finally, companies may also look for financing to sort out financial crises such as amid business recession periods to keep their operations afloat. Whether equity or debt financing, companies must have clear objectives for the monies that they receive to enhance accountability and transparency.
Cleverly, William, & Cleverly, James. “Essentials of Health Care Finance.” 8th Ed., Jones & Bartlett Learning, LLC., 2018
Commonwealth of Australia. Reasons and options for seeking finance. 2019. Web. Retrieved from https://www.business.gov.au/finance/seeking-finance/reasons-and-options-for- seeking-finance on 24th March 2020