Debt & Equity Debt Financing Essay

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Debt financing tends to have a lower cost than equity financing and is often easier to acquire. However, because debt financing represents a fixed obligation in terms of interest and repayment, it increases the risk of the firm. Thus, some amount of equity financing is ideal with respect to keeping the firm's risk level within reason. The level of risk a firm should have will vary depending on a number of variables. In some industries, cash flow is stable so more risk is reasonable; in other industries cash flow is unstable so lower risk is preferred.

Another consideration is control of the company. Because equity represents an ownership stake, firms often wish to control the amount of ownership stake that they surrender in their quest for financing. Debt financing is therefore sometimes preferable because it does not result in the surrendering of ownership stake.

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In some cases, preferred shares can be issued for this purpose, although their use is less common.

One final consideration with respect to the financing question is the time frame. The time frame for the financing should equal the time frame for the assets purchased. If the funds are required for general growth, then equity is appropriate. If the funds are for a long-term project such as a capital asset, then debt financing can be structured for the life of that asset. If the financing requirements are short-term, then the best approach is revolving credit or other short-term forms of financing. The company's capital structure should ultimately be the sum of these decisions, brining asset life and financing life into equilibrium.

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