Debt financing, as opposed to equity financing, allows organizations to collect the necessary capital for supporting operational expansion by furnishing instruments of debt such as bills, bonds, debentures, and notes.

This involves the lending party extending a loan or a debt to an enterprise for a preset duration in consideration of availing interest on the loan offer. There are multiple categories of investors, namely, institutional investors and retail investors. This specialised form of financing is also termed financial leveraging.

Basically, there are two main kinds of debt financing:

Short-term debt financing

Companies can utilize short-term debt financing to capitalise their net working capital for commencing everyday core functions. These operations include remunerating employees, purchasing stock and machinery, and settling supply and maintenance costs. The designated duration for loan repayment is generally one year.

A prominent form of short-term financing is a credit-line which is provided against collateral. It is generally useful for businesses that have trouble maintaining an affirmative cash flow. Notably, in the case of startups where general expenses overwhelm current revenues, short-term financing can prove extremely handy.

Long-term debt financing

Businesses are constantly on the lookout for long-term financing outlets that are necessary procuring fixed assets like building infrastructure, tools and machinery, and other equipment. The assets that are obtained can also be optimized for loan securing in the form of collateral. The designated timeframe for loan repayment is generally a span of ten years, with set interest charges and probable monthly payments.

Debt financing can be funded through bank loans, bonds, bearer bonds, or debentures.

Amongst the aforementioned finance options, bank loans are the most prevalent type of debt financing. Bank Loans can be either secured or unsecured.

A significant plus side of debt financing is that the interest rewarded is tax-deductible. It reduces the company’s tax commitments. Moreover, the primary payment and interest charges are a set amount suggesting that the loan is repaid at a regulated rate. It enables in-depth and to the point forecasting that further makes room for hassle-free budgeting and seamless financial management.

The author is Co-Founder & CEO, Smartcoin

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