Week 3 Discussion 1: Debt versus Equity

Differentiate between debt and equity.  As a manager, which method would you choose to increase operating capital?

Debt versus Equity-Sample Solution

Debt refers to the capital companies raise through borrowing and represents the money it owes to another entity (Ainsworth & Deines, 2019). Companies borrow it from loans, debentures, or bonds from financiers with no ownership rights. On the other hand, equity represents a company’s net worth and a permanent source of capital. Equity includes ordinary or preference shares and reserve and surplus, which companies raise by giving investors ownership rights (Ainsworth & Deines, 2019). Another difference is that debts are a company’s liability and have maturity dates and fixed interest rates which borrowers must honor to avoid incurring additional penalties. In contrast, equity is a company’s asset that does not have a maturity date and results in dividends when profits are made.(Debt Versus Equity Essay-Example)

Furthermore, Ainsworth and Deines (2019) observe that financiers can secure or unsecured debts. When giving out secured debts, they require borrowers to pledge assets they can sell to retrieve the borrowed funds in case the borrower defaults. The financiers do not require borrowers to pledge assets when giving unsecured debts. In contrast, equity does not require security since the investor gains ownership rights at the company. Lastly, debts incur interest rates against profits, whereas equity results in dividends paid to shareholders based on company profits (Ainsworth & Deines, 2019).(Debt Versus Equity Essay-Example)

As a manager, debt financing is the best option for increasing operating capital. Ainsworth and Deines (2019) illustrate that it is the most appropriate since it does not force the company’s principal owners to give up their ownership. It also leads to tax deductions, which lower the company’s actual cost of paying the loans. Tax collectors may deduct the company’s income taxes from the principal and interest payments. Additionally, debt financing is essential in fueling the business’s growth. It can use long-term and low-interest loans to improve its operations, such as marketing or expanding production activities.(Debt Versus Equity Essay-Example)  

Reference

Ainsworth, P., & Deines, D. S. (2019). Introduction to accounting: An integrated approach. (8th ed., pp. 363-445). Hoboken, New Jersey Wiley