Informational: Equity:Debt:Lines of Credit

Equity:
• Equity represents ownership in the firm.
• Equity renders no contractual commitment (legal) to return the original amount invested, or to necessarily pay dividends as a return on that investment
• Owners are ‘residual claimants’ …they get what is left over after all the firm’s legal commitments have been satisfied.
Debt:
• Debt gives rise to fixed contractual commitments.
• Those commitments at a minimum include:
– Repayment of the principal borrowed
– Payment of interest for the use of the amount borrowed.
– Adherence to other agreed terms such as limiting the amount of additional debt taken on, maintaining financial ratios, regular financial reporting, etc.
Lines of Credit:
• Types of Lines of Credit include:
– Operating (demand)
– Term (revolving)
• Used for working capital purposes:
– Financing receivables
– Inventory
– Ongoing corporate activity
• Banks may require a ‘clean up’ period in which a firm has a zero balance on its L/C to ensure that the bank is not providing permanent financing.