Almost every business, large or small, needs to borrow money at some point. Whether it’s for large assets like land and buildings, or simply supplies to keep a business running, debt financing plays an important role in modern business. Simply put, debt financing is borrowing money to keep a business running, expand a business, or acquire assets. Long-term debt financing is typically associated with larger assets, such as machinery, equipment, or real estate, and is repaid over many years. Short-term debt financing, on the other hand, is most often used for business operations like utilities or payroll, and is often paid off within a year.
The alternative to debt financing is equity financing, which involves the acquisition of money from investors and/or savings. However, we will focus on debt financing in this article.
While the majority of businesses in Britain receive their financing from internal finance, 39 per cent rely on external sources of financing, usually debt financing in the form of a bank loan. The company will agree the term of the loan and the interest rate, either variable or fixed, with the lender. As with any loan, companies will need to show the bank how they are going to repay the money and secure the loan against an asset. The asset is usually a premises or equipment that covers the value of the loan. In addition, a bank may require that some type of personal property be offered as collateral.
Financial institutions tend to favor companies that have good management, reliable projected cash flow, and good growth potential. The business may need to show that it can meet the monthly payments on the revenue projected in your business plan. Of course, the business will have to adhere to the payment schedule specified by the lender, and may run into trouble if it deviates from it. Longer-term loans are usually made this way.
Debt financing products
Businesses seeking debt financing to cover day-to-day operating costs often opt for an overdraft over a long-term loan, though these are losing popularity due to high interest rates, steep penalties, and repayment obligations. upon request.
There are many options currently available to businesses looking to avail of debt financing. Factoring and invoice discounting allow small businesses to borrow against sales, while leasing allows you to borrow money to buy machinery or equipment. However, term loans are still the most popular with businesses and banks. From the point of view of financial institutions, it allows them to impose regular payment schedules at fixed periods, which is less risky than overdrafts. Many businesses have been known to get angry with banks because they couldn’t pay overdrafts when asked. This provides an overview of the debt financing products available.
Each lender has its own products, rules, and rates, so it pays for any business to find an agreement that suits their needs. Some companies even offer credit cards designed for small businesses to pay for incidental day-to-day expenses. However, these can become an expensive luxury if the balance is not paid off every month.
debt over equity
Debt financing continues to be more popular than equity financing for a number of reasons. Interest paid on loans is often tax-deductible, and debt financing is available in small, affordable amounts, while equity financing tends to be in large amounts. Also, with debt financing, the lender has no say in how the business is run and has no right to the property or profits of the business. Another advantage is that business profits can be kept within the business while the loan is used for day-to-day operations or asset acquisition.
Debt financing is not an appropriate option for all businesses. However, for small businesses where equity financing is not an option, it can be a valuable service in running day-to-day operations and purchasing equipment. Although loans often tend to be short-term and at high interest rates, debt financing remains a popular option for many businesses.
