Following our blog on sources of funds last week, let us dive this week into debt as a source of finance.
Debt financing for a company is just the act of borrowing money with a commitment to repay within a specified period of time. Interest on the borrowed money must be paid in addition to the principal amount. Businesses that require significant capital expenditures frequently choose debt financing, by which the firm's assets are used as collateral for the borrowed money.
There are different forms of debt financing. These include:
Loans: This is the most widely used form of debt financing. Here, businesses put up either a personal asset (in the event of a new business) or the asset of the company as collateral to obtain a loan from either a commercial bank or other financial organisations. Depending on the business's financial needs, loans can be either short, medium or long-term and are subject to periodic specified interest payments.
Bond issues: For well-established businesses needing money for expansion or long-term initiatives, debt financing is a good alternative. It is often raised by offering bonds to the general public and distributing the proceeds from the sale of the bonds. Depending on the terms of the arrangement, bonds could remain valid for a very long time.
Trade credit: This is a short-term financing option that enables companies, particularly start-ups, to buy goods and pay suppliers back at a later date. For this type of financing, the supplier and company often have a contract in place.
Instalment purchase: This relates to making regular payments for capital expenditures, such as a building or piece of equipment. It is another form of debt financing in which the asset in question is mortgaged until full payment is received.
Advantages and disadvantages
The advantages of debt financing over equity include:
Ownership of business - once the debt is fully paid, the owner does not have to share ownership rights with the lenders.
Interest paid on the loan is deductible from tax.
While the disadvantages include:
When applying for a financial loan, a company or its owner is typically asked to put up assets belonging to a person or company as security. If they are unable to make payments, they run the danger of losing these assets.
The strain of repaying a loan's principal and interest might be too much for the company.
A business's creditworthiness could be negatively impacted if it receives too many loans.
To sum up, when looking for financing for your business, it's crucial to weigh all of your alternatives. In order to ensure you are on the correct path, it is also a good idea to design a strategy for funding your firm.
Email us at: enquiries@ovacgroup.com for a free consultation with our team specialists to help you to identify and obtain the appropriate funding for your business.