finance 0106

When a company is created, it needs a capital which can be brought by the founders themselves or by doing a loan to a commercial bank. Generally, a company can finance most of its activity using its internally generated cash flow. If the company needs more money it can pick out between two solutions to finance itself : the debt financing and the equity financing.
The debt financing consists in borrowing money by doing a loan to a bank, or by issuing its own bonds (borrowing money to private individuals).
It is often cheaper to issue bonds, because the market can better judge the creditworthiness of the company and create lower interest rate. Bonds have a long term maturity and their interest rates are fixed.
The equity financing can only be used by the limited partnerships. It consists in issuing shares sold to private individual, the shareholders, giving them in return part of the ownership of the company. It means that they generally have a right to vote, and if the company does profits, part of those profits are poured again as dividend to the shareholders. To raise money, a company can issue new shares, normally offered first to existing shareholders (rights issue). The incomes received by issuing new shares creates assets to finance the company’s projects.
How to choose between equity financing and debt financing?
First of all, bond interests are tax deductible( the company can deduct its interest payments from its profits before paying tax) whereas dividend are paid out of already taxed profits.
But, issuing bonds, the company increases debt, and as a result increases risk : bonds have to be payed, even in a year without any profit from which to deduct it, and the principal has to be repaid when the debt matures. Issuing shares is safer, companies are not obliged to pay dividends or repay share capital.
As a conclusion, both ways to finance a company have advantages and disadvantages, and according to the company audacity and the economic conjuncture, each one has to choose his own tactics.

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