Business Financing and the Capital SStructure - Assignment Example

Business Finance and Capital Structure al Affiliation) Business can get capital finance from a variety of resources whichare broken down into two broad categories, debt and equity. One has to do critical comparison of the two methods of business finance to come up with an optimal solution that they can use to raise additional finance. Debt is the borrowing of money by the company using the various debt instruments and then repaying the money plus an interest. Equity is the selling of the company’s interests in a bid to raise money.

Debt has several advantages over equity. First, in debt financing the company does not share part of the interests of the company. This fact ensures that there is no dilution of the company’s ownership. Second, the company is entitled to pay the amount they borrowed plus a predetermined interest. This implies that the company can budget efficiently on how to repay its debt. It does not have to share the future profits of the company in any case the company becomes successful. The interest paid on the debt that the company takes are taxation allowable expenses.

This implies that the interests can lower the amount of tax a company pays resulting to it lowering the overall cost of capital. The process of raising debt finance is simple and easy since the company is not entitled to comply with any securities regulations and laws. Lastly, in debt finance the company does not have to hold periodic meetings to explain their various actions to the debt holders.Despite the many advantages that debt finance has, it also has some disadvantages. First, unlike equity, there must be payment of the debt at some point in time creating obligations to the company.

Debt financing also come along with fixed costs which at times can be high. High interest costs increases the risk of insolvency of a company especially on difficult financial periods. Lastly, debt financing require companies to pledge their assets as collateral. Equity financing generates large amounts of money which do not require repayment. What the company has to do is to only share a portion of their profits to the new investors who become part of the company. The company can use this non-refundable money to expand their operations or diversify its business to generate future cash flows.

Equity finance also helps the company to maintain a low leverage which would increase its chances of getting debt finance in the future. The major disadvantage of equity financing is that the company has to loose part of the ownership of the company to the new investors and they will have to take part in the decision making processes of the business. In some circumstances, the profits in which one shares with the new investors will exceed the amount of money given by them (Dlabay & Burrow, 2008).

Selecting an investment bank by a company to assist in the process of raising capital is appropriate. The bank will persuade its client to invest in the company. The bank will advise accordingly the company on which way is the most convenient to raise capital. A major challenge of using an investment bank is that it provides these charges at a fee. Common stocks are very risky and therefore require a high level of return to compensate for the risk. On the other hand, corporate bond are less risky than them and therefore has less returns as compared to common stock.

It is convenient for a company to diversify its risk portfolio by using both equity and debt finance. This ensures that the company enjoys all the benefits attributed to these sources of business finance. ReferenceDlabay, L., & Burrow, J. (2008). Business finance. Mason, Ohio: South Western.