Debt and Equity: Definitions, Key Metrics, Context & more

📖 DEFINITIONS

✦ DEBT:

Money borrowed by a company that must be repaid with interest; It includes loans, bonds, or any other forms of borrowing with a set repayment schedule and interest payments.

✦ EQUITY:

Ownership in the company, typically through the sale of shares; Investors who provide equity receive ownership and may earn returns through dividends or appreciation in share value.

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📐 KEY METRICS

✦ DEBT

Interest Rate → The percentage charged on the borrowed amount, which the company must pay on top of the principal loaned;

Debt-to-Equity Ratio → A key measure of a company’s financial leverage, comparing total debt to total equity;

Repayment Schedule → The timeframe within which the company must repay its loan, usually through monthly or annual payments.

✦ EQUITY

Return on Equity (ROE) → A measure of a company’s profitability relative to shareholder equity, showing how effectively the company is using investors' money;

Ownership Percentage → The amount of ownership an investor holds after providing capital through equity, typically represented in shares;

Dividend Yield → The percentage of equity paid out as dividends to shareholders, reflecting income from holding shares.

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⚙️ CONTEXT

✦ DEBT

Position in Financial Statements → Debt appears as a liability on the balance sheet, with interest payments recorded on the income statement under expenses;

Debt financing allows companies to raise funds without giving up ownership, but it creates fixed repayment obligations.

✦ EQUITY

Position in Financial Statements → Equity appears in the shareholders’ equity section of the balance sheet, reflecting the ownership in the company;

Equity financing does not create repayment obligations, but it dilutes ownership by issuing shares to investors.

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📊 MORE

✦ DEBT

Advantages → Companies retain full ownership and only need to repay the loan, with interest being tax-deductible. Debt is often cheaper than equity in the long term;

Disadvantages → Fixed repayments must be made, regardless of business performance, which increases financial risk in downturns.

✦ EQUITY

Advantages → There’s no obligation to repay the capital, and investors share in the risk and reward. Equity financing can strengthen the company by bringing in expertise from investors;

Disadvantages → Issuing equity dilutes existing ownership, and investors expect returns, either through dividends or share value appreciation, which may pressure management.

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💡 SUMMARY

✦ DEBT → Borrowed funds that must be repaid with interest, allowing the company to raise money without giving up ownership.

✦ EQUITY → Ownership capital raised by selling shares in the company, offering investors a stake in the business without requiring repayment.

→ Both debt and equity are important tools for financing a business, with debt offering control but financial risk, and equity providing capital without repayment but reducing ownership.

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