What Are the Two Main Sources of Finance for Businesses?

by Marquis Codjia; Updated September 26, 2017

Add liquidity management to the long list of issues facing corporate leadership. In modern-day economies, businesses must strike the right balance between funding short-term operating activities and covering long-term expansion initiatives -- such as mergers and acquisitions. Companies rely on various funding sources, but investors generally group them in two clusters: debt and equity.

Equity

In search of ideas to increase sales and gain market share, a company’s leadership reaches out to potential investors and tells them why they should pour money into the business. Equity is a powerful lever to minimize the malaise of a bad economy, especially if conditions on credit markets are disadvantageous. A company can seek equity financing through stock markets, also known as securities exchanges or financial markets. It does so by issuing shares of equity -- or stocks -- and works under the guidance of investment bankers to find the best time to raise funds.

Relevance

One important benefit of raising equity may be that it acts as a feedback loop for corporate management. Top leadership can gauge investor interest by determining how many financiers line up to buy the firm’s shares. Purchasers of equity shares are also known as stockholders or shareholders. They receive cash distributions on a periodic basis and make profits when share values rise. In modern economies, the regulatory environment around equity reporting has become more rigorous. Accordingly, such government agencies as the U.S. Securities and Exchange Commission have established adequate norms for reporting corporate financial information.

Debt

The leaders of consistently profitable companies generally like to highlight corporate performance during investor presentations or in accounting statements. In these reports, they often enjoy regaling investors with tales of operating prowess and competitive victories, telling financiers what they did to outperform rivals. Business heads use debts to finance a host of operating activities, from such mundane expenses as office supplies and salaries to long-term charges (purchases of heavy-duty equipment, for example). Corporate liabilities include accounts payable, commercial paper and bonds payable.

Strategic Importance

Given the importance of debt management in the way a business funds its activities and administers its reputation, department heads rely on analytical tools to gauge the firm’s economic soundness. Although mostly technological, an effective debt-management tool kit enables a company to track its indebtedness and payment dates. The ability to borrow at preferential rates often makes the difference in the marketplace, especially if the amounts are substantial.

Relationship

Organizations rely on adequate decision-making processes to evaluate funding needs and come up with cheap ways to pay for expenses. Although debt and equity are distinct items, they are part of the arsenal that businesses use to build a strong war chest, financially speaking.

About the Author

Marquis Codjia is a New York-based freelance writer, investor and banker. He has authored articles since 2000, covering topics such as politics, technology and business. A certified public accountant and certified financial manager, Codjia received a Master of Business Administration from Rutgers University, majoring in investment analysis and financial management.

Cite this Article A tool to create a citation to reference this article Cite this Article