Financing

What is 'Financing'

Financing is the act of providing funds for business activities, making purchases or investing. Financial institutions and banks are in the business of financing as they provide capital to businesses, consumers and investors to help them achieve their goals. The use of financing is vital in any economic system, as it allows companies to purchase products out of their immediate reach.

BREAKING DOWN 'Financing'

There are two main types of financing for companies: debt and equity. Debt must be paid back, but it is often cheaper than raising capital due to tax considerations. Equity does not need to be paid back, but it relinquishes ownership to the shareholder. Both debt and equity have their advantages and disadvantages. Most companies use a combination of both to finance operations.

Equity Financing

Equity is another word for ownership. For example, the owner of a grocery store chain needs to grow operations. Instead of debt, the owner would like to sell a 10% stake in the company for $100,000. Companies like equity because the investor bears all the risk; if the business fails, the investor gets nothing. At the same time, giving up equity is giving up control. Equity investors want to have a say in how the company is operated, especially in difficult times. So, in exchange for ownership, an investor gives his money to a company and receives some claim on future earnings. Some investors are happy with growth in the form of share price appreciation; they want the share price to go up. Other investors are looking for principal protection and income in the form of regular dividends.

Debt Financing

Most people are familiar with debt as a form of financing because they have car loans or a mortgages. Debt is also a common form of financing for new businesses. Debt financing must be repaid, and lenders want to be paid a rate of interest in exchange for the use of their money. Some lenders require collateral. For example, assume the owner of the grocery store also decides that she needs a new truck and must take out a loan for $40,000. The truck can serve as collateral against the loan, and the grocery store owner agrees to pay 8% interest to the lender until the loan is paid off in five years. Debt is easier to obtain for small amounts of cash needed for specific assets, especially if the asset can be used as collateral. While debt must be paid back even in difficult times, the company retains ownership and control over business operations.

RELATED TERMS
  1. Debt Financing

    When a firm raises money for working capital or capital expenditures ...
  2. Equity Financing

    The act of raising money for company activities by selling common ...
  3. Cost Of Capital

    The required return necessary to make a capital budgeting project, ...
  4. Long-Term Debt To Capitalization ...

    A ratio showing the financial leverage of a firm, calculated ...
  5. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used ...
  6. Asset Financing

    Using balance sheet assets (such as accounts receivable, short-term ...
Related Articles
  1. Markets

    Is Equity Financing the Right Choice for Your Business?

    Discover the benefits and drawbacks of equity financing for a small business, and learn when equity financing should be used instead of debt financing.
  2. Investing

    What is Debt Financing?

    When a company needs to pay for something, it can pay with cash, or it may finance the purchase. Financing means that it gets the money from other businesses or sources, in return for obligations. ...
  3. Managing Wealth

    Small Business Financing: Debt Or Equity?

    There are two sources of financing for small businesses: debt and equity financing. This article explains both.
  4. Managing Wealth

    4 Ways Millennials Can Buy Private Businesses

    Buying private businesses is a good way to have greater control over your investments while increasing your income and avoiding the fluctuations of the market.
  5. Markets

    Choose The Best Way To Fund Your Startup: Are Loans Or Equity Right For You?

    Which is better for a startup - debt or equity? Here are the advantages, challenges, and criteria.
  6. Investing

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  7. Markets

    The 4 Best Websites For Small Business Loans (EBAY, PYPL)

    Discover some of the best websites that small business owners utilize to obtain necessary financing at competitive interest rates.
  8. Investing

    Financial Statements: Long-Term Liabilities

    By David Harper (Contact David)Long-term liabilities are company obligations that extend beyond the current year, or alternately, beyond the current operating cycle. Most commonly, these include ...
  9. Markets

    3 Companies That Hate Debt Financing (CMG, BBBY)

    Learn how companies such as Chipotle, Bed Bath & Beyond, and Paychex are able to maintain impressive levels of growth without debt financing.
  10. Markets

    Getting Government Loans For Your Small Business

    Would a government loan provide a more cost-effective way to finance your business? See whether your company qualifies for a government loan.
RELATED FAQS
  1. How does a company choose between debt and equity in its capital structure?

    Learn about the benefits and drawbacks of debt and equity financing and how companies compare different capital structures ... Read Answer >>
  2. What are the different equity financing options available to companies in the United ...

    Learn what equity financing options are available to small, mid-sized and large companies within the United States and understand ... Read Answer >>
  3. What do people mean when they say debt is a relatively cheaper form of finance than ...

    In this case, the "cost" being referred to is the measurable cost of obtaining capital. With debt, this is the interest expense ... Read Answer >>
  4. Which financial ratio best reflects capital structure?

    Learn about the debt-to-equity ratio and why this metric is widely considered the most useful reflection of a company's capital ... Read Answer >>
  5. How does a company's capitalization structure affect its profitability?

    Learn about capitalization structure and how the combination of debt and equity a company uses to fund operations can affect ... Read Answer >>
  6. What are some ways of financing an acquisition?

    Learn about how business acquisitions are financed, from using private equity funds to receiving huge acquisition loans from ... Read Answer >>
Hot Definitions
  1. Poison Pill

    A strategy used by corporations to discourage hostile takeovers. With a poison pill, the target company attempts to make ...
  2. Glass-Steagall Act

    An act the U.S. Congress passed in 1933 as the Banking Act, which prohibited commercial banks from participating in the investment ...
  3. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  4. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  5. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  6. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
Trading Center