Financing of Firms
The money a firm raises for carrying on its business is sometimes called
its financial capital, as distinct from its real capital, which is the firm’s
physical assets, such as factories, machinery, offices, and fleets of
vehicles. Although the use of the term capital to refer to both an amount
of money and a quantity of goods can be confusing, it will usually be clear
from the context which sense is being used.
The basic types of financial capital used by firms are equity and debt.
Equity is the funds provided by the owners of the firm. Debt is the funds
borrowed from creditors (individuals or institutions) outside the firm.
Equity
In individual proprietorships and partnerships, one or more owners
provide much of the required funds. A corporation acquires funds from its
owners in return for stocks, shares, or equities (as they are variously
called). These are basically ownership certificates. The money goes to the
company and the shareholders become owners of the firm, risking the
loss of their money and gaining the right to share in the firm’s profits.
Profits that are paid out to shareholders are called dividends.
One easy way for an established firm to raise money is to retain current
profits rather than paying them out to shareholders. Financing investment