Debt and Equity in Capital Structure

Debt and Equity in Capital Structure

Definition of Debt:

Debt can be defined or classified as the amount that one party (the debtor) comprised of a corporation, organization, business or an individual owes to another party (the creditor). A debt is occurred or happens usually when a creditor agrees to a contract of lending a particular sum of assets to a debtor. In financial terms, a debt is a method of using predicted future purchasing power in the present before it has been earned. Before a debt agreement can be made between a debtor and a creditor, the method of which the debt is repaid must be determined by the creditor. This is also known as the standard of deferred payment.

Definition of Equity:

Equity can be basically defined as the assets that are owned after the debts that are related to those particular assets have been paid off. For example, a property or a vehicle that has had all of its debt cleared is considered the owner’s equity, simply because he or she can immediately sell his or her asset for a particular sum of cash. In short, in an accounting context, Shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or similar terms) is the outstanding interest in assets of a corporation, extended among individual shareholders of a common or preferred stock.

Pros and Cons of Debt:

The major advantage an organization can gain from a debt financing is it allows the founders to retain ownership of the organization or company. Basically what this means are the founders or the owners aren’t required to answer to any partners and/or investors. Furthermore the founders get to keep all of the profits that the organization or company makes. Other than that, if a business is financed via debt, the interest that is repaid from the loan is tax deductible, thus lowering the tax liability of the organization or business. Debt financing also means that the lender from whom the organization, company or business borrows from does not share the profits and all that is required is the repayment in a timely manner.

The major disadvantage of debt financing is in the form