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- Understanding Sources of Finance: Equity vs Debt | Learning Finance Series 005
Understanding Sources of Finance: Equity vs Debt | Learning Finance Series 005
Explore the concepts of equity and debt as sources of finance in video 5 of Learning Finance Can Be Fun series. Learn about direct and indirect sources of finance and how they impact businesses.
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Video Transcript
Welcome to this video 5 in the series Learning Finance Can Be Fun.
In this video, I am going to deal with two important sources of finance, namely equity
and debt.
Friends, broadly, there are two categories of sources of finance.
One we could call them as direct source and another indirect source.
What is this direct source?
Direct sources of finance are those who associate with the business to finance it.
That's their objective.
They have no other business interest.
They want to finance this company, this entity and therefore they get associated with the entity.
The other category which is indirect sources of finance, they get associated for a business reason.
For instance, there could be a vendor who supplies goods.
could be an employee who wants to render one's own services and talent.
Now indirectly sometimes they happen to finance the entity and we are going to discuss about
these indirect sources in a separate video.
For now I am going to restrict my discussion.
So when we talk about direct sources of finance broadly we speak about two categories.
The ones that I mentioned on the title slide, debt and equity.
So what is debt?
Debt simply means that we borrow money from someone who is willing to lend money to us
at a defined rate of interest.
Equity on the other hand is like seeking someone else's money as an investment, not by way
of lending the money, but by way of investing.
and we are going to see the difference between these two categories in the next slide.
their money to work, they could wear either of the two hats. They could wear the hat of an investor
who wishes to be a part of the business, who wants to be a part owner of the business.
On the other hand, the lender is one who is not interested in being an investor but rather is
willing to provide debt. In other words, lender is someone who is willing to lend a sum of money
for a defined consideration. So there is a difference in the expectation of
investors and lenders. Investors look for capital appreciation. They hope that the
money that they invest grows in multiples. They would share a part of the
profits and as the value of the firm grows, the value of their investment also
grows. On the other hand, lenders are those who don't want to take undue risk. They are
quite happy to...
get a defined return which we call as interest but their predominant
consideration is safety of principle. So therefore lenders take steps to protect
their principle by way of mortgage, hypothecation, guarantees and so on. Now
let's talk about how does it make a difference from the company's
perspective who is taking this money. From company's perspective the investors
Investors who give the company money don't create an ongoing burden because there is
no contract which mandates the company to pay a certain amount of profit what is called
as dividend which is the share of the profits.
However, from the company's perspective the burden is quite high and of course in one
of the later videos we will discuss the concept of cost of capital.
At that time I will give you more details about this.
For now, we could say that investors do not have contracts.
actual entitlement. However, their expectation that the company flourishes and their investment
multiplies is quite high and that expectation becomes a reasonably high burden on the management.
On the other hand, the lenders have a defined set of obligations whether it comes to repayment
of principal, whether it comes to payment of interest. The obligations are well defined
