Similarities & Differences Between Debt And Equity With Relationship

Debt Vs Equity Financing Pros And Cons

1. A Debt is the Long-Term Liability of a business. It is payable over long period of time i.e., more than one year to outsiders of the business i.e., creditors, banks, financial institutions, etc. The best Example is Bank Loan. It is financed by the business to utilize different projects or to start a business when the group of people lack sufficient funds but have skills to establish a well renowned business. This process of raising money for various projects of the business is called Debt Financing while Equity is the right of the owners of the business (Shareholders or Stockholders) who invested in the business in order to get fair return (Dividend) of their investments in the form of Share Investments in a company or corporation and such way of raising money for running various projects of the business is called Equity Financing.

2. A Debt is payable by the business to outsiders of the business i.e. Banks, Financial Institutions, etc., while Equity is payable by the business to shareholders or stockholders who are internal resources of the business.

3. A Debt is the calculated by divided by Total Liabilities divided by Total Assets (Debt Ratio) While Equity is the Difference Between Assets And Liabilities through Accounting Equation (Equity = Assets - Liabilities) or it is calculated by preparing Statement of Changes In Equity. In case of Sole Proprietorship Business, Capital is calculated by preparing Statement of Owner’s Equity to find out Total Owner’s Equity.

Similarities Between Debt And Equity

1. Both are used to finance different projects of the business. Initially, business needs finance to start different projects. So both Debt Financing And Equity Financing provides resources to finance the projects of the business.

2. During the time of Emergency, both source of financing plays a vital role to avoid heavy losses to the business. For Example, if the business suffers a loss, then it needs finance to fund different projects so that these can not be stopped at every cost and in future these projects provides a great return to the business because the continuity of the projects is the key to success if these are operating effectively.

3. Retained Earnings are used in case of crisis and these are created for emergency and for the profitable activities of the business’s owners. Finance taken from Banks can be utilized in different projects to generate reasonable profits from these in future, so that the business will carry on for a long period of time.

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Relationship Between Debt And Equity

There is a strong relationship exists between Debt And Equity as both provides resources (Assets) to the business. If one fails, then other can work. For Example, if the business operations fails, and company in trouble and under the burden of debts, then owners of the business, if these are honest, can utilize their funds to Stabilize the Business. Moreover, if the investments from shareholders are not so good, then finance from Banks or other Financial Institutions can finance the business operations effectively. So, both Debt And Equity Financing are the necessary. However, it is better to rely on internal resources of the business (Equity Financing), if the owners are honest and sincere to the business. Also, taking loans is not a good sign for the business as it is a burden on the business and also as the business is obliged to pay to its creditors. Similarly, if the banks provides incentives i.e. interest free loans, then it is a good way to finance for the business, especially in case of Small and Medium Enterprises to run the business.

So, we can say that Debt or Debt Financing is the External Source of the business while Equity or Equity Financing is the internal source of financing for the business.