Debt_vs._Equity_Financing_Paper

A business should compare lease vs. purchase options when it comes to all financial decisions. Leasing or purchasing depends on the situation as all have different benefits. There are many different financing routes that a business can take. Two the commonly used are debt financing and equity financing both of which can be very beneficial. Capital structure is the way business finances their assets through some combination of equity, debt, or hybrid securities. There are many alternative capital structures but only one is more advantageous. Debt financing is basically money that is borrowed to run a business. Think of debt financing as being divided into two categories, based on the type of loan a business is looking for: long term debt financing and short term debt financing. Long Term Debt Financing usually applies to assets a business is purchasing, such as equipment, buildings, land, or machinery (Ward, 2008). With long term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets extends over more than one year. Short Term Debt Financing usually applies to money needed for the day-to-day operations of the business, such as purchasing inventory, supplies, or paying the wages of employees. Short term financing is referred to as an operating loan or short term loan because scheduled repayment takes place in less than one year. A line of credit is an example of short term debt financing (Ward, 2008). Equity financing is money acquired from the small business owners themselves or from other investors. Stockholders purchasing shares in a corporation, for instance, create equity financing, as do angel investors who provide funding. Small business owners may invest their own funds into their businesses, funds gleaned from inheritance, savings, or even the sale of personal assets which then serves as equity financing for the business. Besides contributing to a healthy balance sheet, making a personal investment that serves as equity financing in a business is often necessary to attract other investors and/or lenders. Capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities (Ward, 2008). Trade-off theory allows bankruptcy costs to exist. It states that there is an advantage to financing with debt (namely, the tax benefit of debt) and that there is a cost of financing with debt (the bankruptcy costs of debt). The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing (Ward, 2008). Empirically, this theory may explain differences in D/E ratios between industries, but it doesn't explain differences within the same industry. In conclusion, it is a must for all business to way all options when deciding if leasing or purchasing will have the most benefits. Depending on what the item or structure is will play a vital role in determining which option is better. Debt financing is basically money that is borrowed to run a business. Equity financing is money acquired from the small business owners themselves or from other investors. Capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. Trade-off theory is the more advantageous alternative capital structure. There are many alternatives however; this one is defiantly the better. Reference: Ward, Susan (2008). Equity Financing. Retrieved May 31, 2008 from http://sbinfocanada.about.com/cs/financing/g/equityfinance.htm