What is the difference between debt and equity financing?
Understanding the concept better is essential to understand what each one means.
Every business must have some extra or surplus cash to run without hassles. So, you have two options, debt financing, and equity financing. What are Debt and Equity Financing?
Debt financing
In this type of financing, you borrow to arrange finances. The loan can be either secured or unsecured, and you must pay back the loan within the loan term. These include the following.
- Term loans
- SBA loans
- Line of Credit
- Merchant cash advance
- Invoice financing
- Equipment financing
Equity financing
This is how you raise funds wherein you sell shares of your business, sell a portion of the ownership and get funds. They are of different forms.
- Venture Capital
- Angel Investment
- IPO or Initial public offering
Debt to equity ratio high or low – What is an outstanding debt to equity ratio?
Both types of funding have their risks. Too much equity financing will put your ownership and control over the business at stake if you give away too much equity. Debt funding will not send positive signals about the health of your business that is preferred stock debt or equity.
A debt-to-equity ratio is one of the most crucial metrics that can assess whether the business is in a healthy state or not. The ratio, also known as the D/E ratio, measures how much total debt and equity a company has.
Debt-to-equity ratio formula
Total Liabilities/Total Shareholder Equity= Debt-to-Equity Ratio
Anything less than 1.0 is a good debt-to-equity ratio. If the ratio is negative, it implies a business has more liabilities than assets. Bankruptcy is a hazardous company. A D/E ratio is risky.
The finance industry comprises money lenders, and banks usually have a higher debt-to-equity ratio because they leverage a lot on debt to earn profits by granting loans. On the other hand, the service industry will have a lower debt-to-equity ratio since there are fewer assets to leverage on.
