What are the effects on the financial statements if bonds are used to raise capital versus stock?
JLove asked:
Instead of borrowing cash to pay for its investments, a firm can sell new shares of common stock to investors. Whereas bond issues commit the firm to make a series of specified interest payments to the lenders, stock issues are more like taking on new partners. The stockholders all share in the fortunes of the firm according to the number of shares they hold.
Instead of borrowing cash to pay for its investments, a firm can sell new shares of common stock to investors. Whereas bond issues commit the firm to make a series of specified interest payments to the lenders, stock issues are more like taking on new partners. The stockholders all share in the fortunes of the firm according to the number of shares they hold.
Proceeds from sales of shares of stock appear on the balance sheet as Shareholder’s Equity. Selling new shares will dilute the % of ownership of any existing shareholders. For example, if the company already issues 1 million shares, and decides to raise new capital by selling another 250,000 shares, that will dilute the existing shareholder’s equity by 25%.
Bonds show up on both the balance sheet as liabilities (remaining principal which is unpaid) and the income statement as interest payments under Expenses. Bonds do not dilute shareholder equity, but they represent a more senior claim (higher priority) than stock, if the company went bankrupt.
Bonds are a leveraging technique where a company can borrow (example) 1 million for new facilities, but only pay interest and a portion of the principal each year. However, the interest & prinicipal payments must be paid from operating income before shareholder’s dividends can be paid or shareholder’s equity increased.
If you bought a house, you can take out a mortgage (a bond) and make monthly interest + prinicipal payments, but you keep all the equity gains if the house value increases. The bank gets the P+I but doesn’t get any equity.
Or you can buy a house for cash by finding additional partners (shareholders), but you have to share with them a portion of the equity gains.
Or you can structure your purchase with both techniques in different amounts.