Difference Between Debt and Equity

Debt is money borrowed, equity is ownership in a company, or debt is a liability, while equity is an asset. Interesting, isn't it? The article discusses the concepts and characteristics of debt and equity and covers the difference between debt and equity.

The financing markets have witnessed a lot of dynamism in recent years. New channels and forms of financing emerge, new financial products, and more or less the weight of public financing in the system, depending on the moment of the economic cycle. Despite the diversity of financing products and channels available, debt and equity can be classified into two large financing types. Both are valid for financing the company’s activity but have significant differences and implications. The main difference between debt and equity is that debt is the amount a borrower needs to repay with interest over a set period, while equity is the capital that a company owns and has no repayment obligation.

Content

• What is Equity?
• What is Debt?
• Difference Between Debt and Equity

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What is Equity?

Equity is the Net Worth of a company and the source of permanent capital. Equity investments allow an investor to have an equal portion of ownership in the company. The cost of equity investments is higher than the debt.

Equity comprises ordinary shares, preference shares, and reserve & surplus. 

Equity capital can be obtained through a relative or friend, private capital funds, collective funding platforms, stock exchanges, and markets. The period is generally long-term because it deserves detailed study and finding the person or institution with the necessary capital. In equity investment, there is a risk that success goes hand in hand with the company’s failure. The higher the risk, the higher the expected benefits.

Characteristics of Equity

• The financier expects to get very high returns on his capital, but the situation remains unpredictable. 
• Since there is more uncertainty when discussing the future, the required return is much higher and will depend on the company’s ability to obtain benefits and generate value. 
• The investor can be involved in the management or take complete control if he owns most of the shares. 
• To agree on a price for participation in the company, company valuation methods differ from the scoring systems on which debt financing is based. 
• Shareholders have the opportunity to create wealth through dividend earnings as well as capital appreciation.
• Investors with a more significant risk appetite can consider investing in equity.

What is Debt?

Debt refers to the money that someone borrows from another. It can be an individual or a financial institution. The process of debt forms a relationship between the borrower and lender where the former must pay the borrowed amount to the latter within a certain period. In most cases, the debt amount must be repaid with some interest.

The debt is usually short-term, according to the needs of the borrower. The most common types of debt are loans, credit cards, mortgages, and corporate debt.

Characteristics of Debt

The main features of debt are the following:

• The financier or lender seeks to obtain a return on the money lent. 
• The returns are short-term, and the payment schedule is known in advance. 
• The lender does not participate in the company’s management. 
• The lender considers the company’s past ability to generate cash, projects it into the near future, and determines if the company can repay the debt. 
• The debt computes the company’s liabilities, worsening its credit quality if no other variable changes. 
• Indebtedness reduces solvency and drains the generation of free cash used to service the contracted debt.

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Difference Between Debt and Equity

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