Effect of Equity and Debt Finance on the Balance Sheet Flashcards
Does raising money through equity finance or debt finance impact balance sheet?
Yes
What does equity finance effect on the balance sheet?
Net assets and equity
What does debt finance effect on balance sheet?
Net assets
What changes occur on balance sheet when a company issue shares at nominal value?
1) Increase in share capital (equity section)
2) Increase in assets (cash) (net assets section)
What changes occur on balance sheet when a company issue shares at a premium?
The amount extra to the nominal value is recorded in a share premium account
What is the rule on share premium account?
Must be kept separate
What is the effect on balance sheet when the company takes out a loan?
Increases assets (cash) and liabilities (debt)
What is gearing?
Working out debt to equity ratio
What is the formula for gearing?
Long term debt divided by equity x 100%
What is considered high gearing?
Above 50% (company relies more on debt)
What is considered low gearing?
Below 50% (company relies more on equity)
What are the risks of high gearing?
1) High credit risk
2) High interest payments
3) Limited assets for security
What are the advantages of high gearing?
1) Increases investment power
2) No share dilution – shareholders retain control
3) Potentially higher EPS
What are the benefits of equity finance over debt finance?
1) No repayments
2) Dividends not compulsory
3) Lowers gearing
4) Lower risk
5) No interest
6) No increase in liabilities on the balance sheet
What are the benefits of debt finance over equity finance?
1) Shareholder control is maintained
What will a company consider when deciding between equity and debt financing?
1) Risk
2) Control
3) Financial flexibility
