Discuss in brief the merits and demerits of equity and debt financing or What are two main sources of raising fund for a corporate enterprise
EQUITY FINANCIER OR OWNER'S FUNDS :-
Equity means the ownership to the resources of the business. It is an important source of obtaining funds. The real owners of the business and share holders of the corporation provide funds to the business from their own sources.
Following are the important sources of equity funds :
1. Funds provided by the owners.
2. Additional contribution made by the owners.
3. Earned profits reinvested by the business.
4. Contribution by venture capitalists.
5. Issue of stocks to general investing public.
ADVANTAGES OF EQUITY FINANCING :-
Following are the merits and demerits of equity fund :
1. Sound Base :-
Any business which is financed by the owners fund possesses a sound position.
2. Personal Interest :-
If fund is provided by the owners then they will work with full devotion. The business will flourish and rate of profit will be high.
3. No Interest :-
Interest charges will not be paid by the business concerns on owners fund.
4. Liquidation Of Business :-
The assets of the business will remain with owners if business is liquidated.
5. Return Of Funds :-
During the course of business owners have no fear for the rate repayment of the capital. The owners use their fund for a long time.
6. No Financial Problems :-
In case of equity financing the business concern has a freedom from the financial worries of borrowing.
7. Stable Position :-
In this case there is no burden of fixed interest charges. So business concern can face the crises of recession.
8. Borrowing Ability :-
A business which is financed by the owners fund will be very stable and it has ability to obtain the borrowed capital.
DISADVANTAGES OF EQUITY FINANCING :-
1.Payment Of Income Tax :-
In case of equity financing a firm pays more income tax as compared to credit financing. There is no deduction of interest cost.
2. Idle Funds :-
Some times funds obtained from owners funds remain UN-utilized which may cause more losses.
3. Inability To Make Payments :-
Increase of crises or slump a firm have sufficient to pay day to day expenditure which are essential to run the business.
4. Costly Source :-
Sometimes it has been also observed that equity financing is costly as compared to the credit financing.
DEBT FINANCING :-
When a firm obtains funds for business through borrowing it is called debt financing or credit financing. Today most of the business concerns are not able to finance the business by their own funds. They enter in to agreement with lenders or banks and obtain capital on interest for investment. This practice of borrowing is called debt financing.
ADVANTAGES OF DEBT FINANCING :-
1. Economies Of Large Scale :-
By borrowing the capital business can be expended on large scale. Due to this various types of economies can be availed by the firm.
2. Low Income Tax :-
When income tax is calculated, interest is deductible expense for income tax. So credit offers tax advantages.
3. Short Term Loans :-
Short term loan can be taken by the business concerns from the banks and other sources to meet the urgent expenses.
4. Earning Of Profit :-
The rate of interest is usually less as compared to the rate of return received from the invested capital. So in this way it earns the profit.
5. Control Of Business :-
The entire control of the business remains in hand of the borrowers. Creditors have no role in the business management.
6. Credit Is Flexible :-
The credit may be obtained when needed and it may be returned when it is no more required. There is flexibility in creditors funds nature.
DISADVANTAGES OF DEBT FINANCING :-
The use of creditors fund has the following disadvantages :
1. Interest Payment :-
Interest is regularly paid by the business whether firm is earning profit of loss.
2. Payment Of Credit :-
The principal amount will be paid at the due date without any regard to the financial condition of the firm.
3. Rate Of Interest In Crises :-
During the depression period rate of interest remains same but the rate of return on capital falls and business suffers a loss.
4. Maturity Of Loans :-
At the time of maturity of loans if sufficient funds are not available to meet the loans, the business can be closed.