Debt financing is when a business borrows money from a lending institution to finance short or long term projects, and usually paid back over a period of time, with a set interest rate (Firework Zone, n.d.). With debt financing, a company generally find ways to raise capital such as the selling of "bonds, bills or notes" to investors (Investopedia, Debt Financing, 2010, Paragraph 1). Debt financing is another term for the selling stock to raise capital (Investopedia, Debt Financing, 2010), such as in an Initial Public Offering (IPO).
There are several advantages to debt financing, as this form of financing can be a "useful strategy, particular for companies with good credit and a stable history or revenue, earnings and cash flow" (Reference for Business, 2010, Paragraph 4 ). However, this form of financing may not be as useful for smaller companies, especially for those who are starting out, as debt financing may create "cash flow problems and reduce flexibility" (Reference for Business, 2010, Paragraph 4). With debt financing, company and business owners "retain ownership" and still in charge of running the company (Reference for Business, 2010, Paragraph 6). Debt financing also allow business owners to gain better financial freedom, in addition to enhancing the business credit worthiness (Reference for Business, 2010). Maintaining a good credit rating is essential to any business as it allows the business to successfully apply and receive other types of loans if needed (Reference for Business, 2010).
Although there are several advantages to obtaining debt financing for a company or a business there are however, several disadvantages as debt financing requires the borrower to make monthly payments towards the principal and interest of loan, for a given period of time. This may be a problem for smaller businesses as they may not generate the cash low to keep with the regular monthly payments, which may result in a bad credit rating, hindering the ability to obtain future loans (Reference for Business, 2010). Debt financing lenders generally require some sort of security for their loan, and this could be a problem for small and start up business, as they may have difficulty in proving their ability to pay the loan back (Reference for Business, 2010).
According to Quick MBA (2007) "shareholders' equity is the sum of common stock at par value, additional paid-in capital, and retained earnings" (Quick MBA, 2007, Paragraph 4).In addition, the shareholders' equity represent earnings and not necessarily the cash on hand, as cash balance has a tendency to get low from time to time (Quick MBA, 2007). "In this regard, one can say that retained earnings represent cash that already has been spent" (Quick MBA, 2007, Paragraph 4). In addition there are three primary factors that contributes to changes within a stockholders equity, these changes are the company's overall net income or losses; the payments received from dividends; and the issuances or repurchase of shares and stocks (Quick MBA, 2007).
The optimal capital structure of the firm is the combination of various financial resources that a company uses (Washington State University, n.d.). The capital structure of a business or company can be "viewed as the permanent financing the firm represented primarily by long-term debt, preferred stock, and common equity but excluding all short term credit" (Washington State University, n.d., Paragraph 4).
In viewing Adobe debt ratio, it appears that Adobe Corporation has a relatively low debt to equity ratio, whereas T-mobile's debt to equity ratio is extremely high. However, FedEx's debt to equity ratio falls within the medium range. Computing a company's debt to equity ratio is simply a way to determine how much financial power a company has (Investopedia, Debt/Equity Ratio, 2010). To calculate a company's debt to equity ration, simply divide the company's total liabilities by the company's stockholders' equity (Investopedia, Debt/Equity Ratio, 2010). The number given generally tells a company how much they are currently using to "finance its assets" (Investopedia, Debt/Equity Ratio, 2010). According to Investopedia, if a company utilizes a substantial amount of debt to finance increased projects, the company has the ability to create more income (Investopedia, Debt/Equity Ratio, 2010).
According to Loth (2010), when looking at a company's capital structure, equity in which the company has is usually determined by the company's "common and preferred stock plus retained earnings, which are summed up in the shareholders' equity account on a balance sheet" (Loth, 2010, Paragraph 3).
This invested capital and debt, generally of the long-term variety, comprises a company's capitalization, i.e. a permanent type of funding to support a company's growth and related assets.
