BUSINESS FINANCE

Sources and Uses of Short – Term and Long – Term Funds

 Debt and Equity Financing

o Sources of financing are divided into two major categories: debt financing and equity
financing. The following section describes the features of each source.
 Debt Financing
o can be in the form of borrowing from banks or other lending institutions or issuance
of debt securities
o can also be in the form of advances from stockholders to expedite the process of
raising funds.
o creates a contractual obligation for the borrower to pay the interest managed and the
principal.
o Benefits of Debt Financing:
 Interest Expense is tax-deductible. Unlike cash dividends for shares of stocks,
interest expense provides a tax shield.
 Debt financing allows the company to grow without diluting the interest of the
controlling stockholders.
 Creditors generally do not intervene in the decisions of the management.
o Benefits from debt financing can be realized if the level of debt incurred by the
company is manageable. Too much debt can expose the company to a bankruptcy risk
and this may disrupt of the company.
 Equity Financing
o Refers to issuance of new shares of stocks and retained earnings plowed back into the
operations of the company, also called internally generated funds.
o safest source of financing for a company because it does not require any mandatory
payment of dividends.
o also provides the company financial flexibility. This means that if a company is 100%
financed by equity or its leverage ratio is very low, it will be attractive to creditors.