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Difference between Debt and Equity

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  • Last Updated : 22 May, 2022

Finance required by the business to establish and run its operations is known as Business Finance. No business can function without an adequate amount of funds for undertaking various activities. In order to produce goods or provide services, any business needs money. Longer goals of expansion and growth can only be achieved with the help of the required amount of funds.

Unlike Partnership or Sole Proprietorship, a Company has many options from where it can arrange funds to operate its business. In Proprietorship and Partnership concerns, the funds may be raised either from friends and family or as a loan from a bank. But in the Company form of business, funds can be arranged from various sources. Funds can be classified on the basis of period, ownership, and source of generation. On the basis of the source of generation, funds can be classified into two categories: Internal Source and External Source.

On the Basis of Source of Generation: 

  • Internal Source: Those funds which are generated from inside the business are called Internal Sources of Fund. Collection of receivables and disposing of surplus inventories are some examples of internal sources.
  • External Source: External Sources of funds include those sources that lie outside the organization, such as suppliers, lenders and investors.

Debt-vs-Equity

Debt and Equity are the two major constituents of the external source of finance:

Debt is a type of finance raised by a company from various institutions and individuals to fulfill its long-term goals and objectives. Debt can be characterized by repayment and a fixed interest rate, i.e. the amount raised is repaid to the lender within a fixed duration and fixed interest on the sum is provided to the lender. Debt is considered a liability to the company. Borrowing from banks, loans from various institutions, debentures, loans, etc., are examples of debt.

Equity is a type of finance in which a company raises finance from various institutions and individuals by offering ownership of the company to them in the form of shares. There is no such requirement of repayment and fixed interest in this type of source of finance. Equity shareholders are called owners of the company. They are entitled to get dividends from the profits earned by the company.

The difference between Debt and Equity are as follows:

     Basis                        

Debt

Equity

Meaning        Debt is a type of source of finance issued with a fixed interest rate and a fixed tenure. Equity is a type of source of finance issued against ownership of the company and share in profits.
Time Span          Debt capital is issued for a period ranging from 1 to 10 years. Equity capital is issued comparatively for a longer time horizon.
ReturnsDebt capital has a fixed rate of interest, and the entire amount is repayable.The rate of return in equity capital is not fixed. It depends upon the earnings of the company.
SecurityDebt capital can be secured (against an asset) or unsecured.Equity capital is unsecured since ownership is provided instead of security.
RiskIt is less risky, as interest is provided even in the case of loss and the amount invested can be received back.It is riskier because if the company does not earn profits, then returns can be as low as zero.
Instruments             The instruments used to raise debt are loans, bonds, debentures, etc.The instruments used to raise funds are shares.
StatusDebt is considered a lender to the organization.Equity shareholders are considered owners of the company.
OwnershipIn debt, ownership is not sacrificed.Ownership gets distributed amongst different shareholders according to their shareholdings.
Source

Loans can be taken from banks, and 

debentures and bonds can be issued to various institutions and the general public.

Shares can be issued to the general public and various organizations.
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