Debt vs Equity Financing
Debt vs Equity Financing. The pros and cons: equity vs debt. What institutional investors pay attention to and why.
Equity vs Debt
Investors usually pay careful attention to the debt-equity ratio, as it is one of the possible red flags that indicate a risky investment. The greater the proportion of debt held by the company, the greater the financial risk. This is because debt represents fixed outflows of cash for a certain amount of time in the future. At the same time, inflows of cash may be uncertain. This translates into an uncertain and questionable future cashflow for companies steeped in debt.
Debt Equity Financing
Nonetheless, it is poor business strategy to assume zero debt. Debt is less costly than equity funds, and companies can use debt as a powerful leverage to stimulate further growth.
Debt is thus a powerful instrument that increases both profit and risk. Companies that are able to manage their debt well can thus be extremely successful even with high levels of debt. It has also been observed that companies with the most stable income streams tend to be willing to fund mainly from debt, while companies with more volatile income streams tend to fund more from equity.