Debt Financing

Debt Financing

During the process of business management and expansion, the company periodically needs additional financial resources. In cases like that, the most relevant way is debt financing or equity financing. Each source has its advantages and is very important for future growth.
In this article, We will focus on Debt financing, as one of the frequent ways in businesses.

Debt financing is a process through which a company borrows money to run a business at a fixed or floating interest rate and for a fixed time. The sources of debt financing for a company include banks, microfinance organizations, credit union, etc

We have several ways of debt financing practice in today’s world. What today’s business sector is using as the most efficient ways are mentioned as follows:

Business Loans

Business Loan is a very common and well-used method in companies to expand their business. Such type of finances comes from a bank or other lending institutions. Based on the agreement, the bank is trusting a borrower to repay the loan plus interest at the exact date.

(For more detailed information connect to  DOC. BUSINESS LOANS)


Leasing is one of the most common forms, when a company or private individuals need to finance their assets, such as machinery, equipment, construction equipment, automobiles, etc. A Lease agreement is a contract between a lessee (borrower) and a lessor (owner).  According to the contract, the lessee will monthly pay the lessor the payment for use of this exact asset.

(For more detailed information connect to  DOC. LEASE) 

Trade Credit

Trade credit is the most effective way for businesses to solve the short- term working capital problem. It is a form of debt financing that mostly involves two business parties: supplier and buyer. That is why such an agreement is called a business-to-business (B2B) agreement.

(For more detailed information connect to  DOC. Trade Credit)


For companies and government, a very common way is to issue Bonds to finance some projects and operations. Issuer offers interest (coupon) to the lender as a monthly payment and repays the principal (face value) at the maturity date.

The bond can be like a form of a loan, where the issuer is the borrower and the bondholder is a lender. The bond agreement includes the end date when the principal of the loan should be paid to the bond owner and usually includes the terms for variable or fixed interest payments made by the borrower.

(For more detailed information connect to  DOC. Bonds)

Besides, debt financing can be divided into two categories based on the type of finance you are seeking: long-term debt financing and short-term debt financing. 

Debt Financing

Long-Term Debt Financing

Long-term debt financing usually is used in cases when a company wants to grow by long-term assets purchasing such as equipment, buildings, land, or machinery.
With long-term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets extends over more than one year. If there is a long-term asset, it will be acceptable for lenders to risk long-term financing.
A lender will normally require that long-term loans be secured by the assets to be purchased.

Short-Term Debt Financing

Short-term debt financing usually applies to money needed for the day-to-day operations of the business, such as purchasing inventory, supplies, or paying the wages of employees.
Short-term financing is referred to as an operating loan or a short-term loan because scheduled repayment takes place in less than one year. A line of credit, credit cards, and business overdrafts are examples of short-term debt financing. Lines of credit are also typically secured by assets (or collateral).
Short-term financing is commonly used by businesses that tend to have temporary cash flow issues when sales revenues cannot cover current expenses.

Advantages of Debt Financing

The main advantage of debt financing over equity financing is that the lender does not take an equity position in your business. You retain full ownership and the lender has no control over the running of the business. On the other hand, with equity financing, the investors become part owners of the company and therefore have a say in how the business is managed.
Debt interest costs are fully tax-deductible as a business expense. This is a benefit for companies, interest rate expanse can be written in the company’s P/L analysis and show a clear picture of the company’s real profit.

Disadvantages of Debt Financing

For financing, banks normally require assets of the business to be posted as collateral for the loan. If the business does not have collateral, the lender will require personal guarantees from the business owners. As an owner, this leaves you personally responsible for paying back the loan. If the business is in difficulty and is unable to make the loan payments, whatever personal assets you have posted as collateral (house, car, investment accounts, etc.) can be seized by the bank.
With debt financing, the fixed repayment schedule and the high cost of loan repayment can make it difficult for a business to expand.

Nowadays, debt financing is a very popular source of financing for businesses, as it enables the business to not only meet its working capital requirements but also to expand its business.

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