Type: equity or debt
There are two basic types of finance available to any business:
- Equity is share capital risked by the shareholders. As long as the business is a going concern, this capital is not repayable, so it is considered as permanent capital. If the business makes profit, the shareholders will receive a proportion of this in the form of a dividend. Dividend, however, is optional as it is decided by the board of directors, so in a bad year a nil dividend may be announced. Equity also includes profits that have retained in the business for the purpose of re-investment.
- Debt includes all forms of borrowing from sources external to the firm. These funds need to be repaid and lenders will expect a reward in the form of interest. Interest is a legal charge and must be paid before any profit is distributed. In a bad year, interest must still be paid.
The relationship between the value of loans and the value of equity is the firm's gearing ratio. If a higher proportion of finance comes from loans than equity the business is said to be highly geared.