Capital Structure
Capital Structure
In finance, the term “capital structure” refers to the way a firm finances its assets. Generally speaking, there are two main forms of capital structure: debt financing and equity financing (Cumming 52; Myers, 83). Each type has its own advantages and disadvantages, and an essential task for the successful manager of a firm is to find an optimal capital structure in terms of risk and reward for stockholders. When making decisions that affect capital structure, managers must be aware of the impact capital structure has on the firm’s potential for future success, as well as the advantages and disadvantages of debt versus equity financing.
Debt financing can be defined as when a firm raises capital by selling bonds, bills, or notes to individual and/or institutional investors. These individuals or institutions become creditors and in return for their loan, they receive a promise that the principal and interest on the debt will be repaid. Banks are the most popular source for debt financing and bank loans are often of great importance in the startup of new firms (Richards 1). There are many advantages to using debt to finance assets, but there are also some disadvantages.
One of the greatest advantages of debt financing is that the owner of the firm maintains ownership and control of the business. When an entrepreneur borrows money from an outside source, he or she is obligated to make payments on time. After these payments are made and the full principal and interest have been paid back, the entrepreneur has no further obligations owed to the outside source. (Richards 1). Another great advantage of debt financing is tax deduction. These deductions are made possible because in most cases, the principal and interest payments on a business loan are classified as business expenses, and can be deducted from your business income taxes (Richards 1). In other words, the government has a percentage of ownership in your business by the tax rate, and the
In finance, the term “capital structure” refers to the way a firm finances its assets. Generally speaking, there are two main forms of capital structure: debt financing and equity financing (Cumming 52; Myers, 83). Each type has its own advantages and disadvantages, and an essential task for the successful manager of a firm is to find an optimal capital structure in terms of risk and reward for stockholders. When making decisions that affect capital structure, managers must be aware of the impact capital structure has on the firm’s potential for future success, as well as the advantages and disadvantages of debt versus equity financing.
Debt financing can be defined as when a firm raises capital by selling bonds, bills, or notes to individual and/or institutional investors. These individuals or institutions become creditors and in return for their loan, they receive a promise that the principal and interest on the debt will be repaid. Banks are the most popular source for debt financing and bank loans are often of great importance in the startup of new firms (Richards 1). There are many advantages to using debt to finance assets, but there are also some disadvantages.
One of the greatest advantages of debt financing is that the owner of the firm maintains ownership and control of the business. When an entrepreneur borrows money from an outside source, he or she is obligated to make payments on time. After these payments are made and the full principal and interest have been paid back, the entrepreneur has no further obligations owed to the outside source. (Richards 1). Another great advantage of debt financing is tax deduction. These deductions are made possible because in most cases, the principal and interest payments on a business loan are classified as business expenses, and can be deducted from your business income taxes (Richards 1). In other words, the government has a percentage of ownership in your business by the tax rate, and the