Your complete Guide to Debt financing solutions
Finance is the lifeblood of business at all stages of development, from Start-ups, to growing or mature businesses ready to scale up. Ensuring you have the right financing solution is critical to that growth. So below we have compiled your complete guide to debt financing.
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- What is debt financing?
Debt financing (also referred to as financial leverage) is when a business raises funds for capital expenditure or working capital by selling fixed income products or debt instruments to individuals or institutional investors. The individuals or investors become creditors and receive repayments on the principal and interest on the debt. Most companies will need some form of debt financing in order to grow.
- What are debt instruments?
Debt instruments are assets that require a fixed payment to the holder, usually with interest. Examples would be bonds (government or corporate) and mortgages.
- Are there different types of debt financing?
Yes, there is a number of options. Bank Loans from financial institutions are one of the most common examples of debt financing. Other options are loans from family or friends, bond issues, government-backed loans, lines of credit (credit cards, mortgages), and equipment loans.
- How does debt financing work?
When a business owner or company needs money, there are three ways to get financing – by selling equity, by taking on debt, or through a hybrid of the two. Debt financing involves selling fixed-income products to get the capital needed to grow and expand.
- What is the difference between debt financing and equity financing?
Debt financing is one way to raise capital in debt markets and is the opposite of equity financing. Equity financing raises capital through the sale of shares. Debt capital is provided by a lender who benefits from the repayment of capital, plus interest. On the other hand, equity financing involves selling a portion of the equity in the company, where the investor retains an equity position in the business.
- When does debt financing happen?
It occurs when a business needs to raise money, whether it be for day-to-day operations, or to make large purchases. Essentially, debt financing facilitates business growth.
- Is there an accounting formula for debt financing?
The formula for the cost of debt financing is:
KD = Interest Expense x (1-Tax Rate)
(KD is the cost of debt)
- Is it better to avail of debt financing short-term or over a longer period of time?
This completely depends on the financial needs of the business as they can differ from one company to the next. The amount of capital needed is the biggest determining factor. Some businesses need to fund their working capital for day-to-day operations, for example, wages or inventory. Here, short-term debt finance like a short-term loan would suffice.
In cases where a business wishes to make a larger financial investment for growth, like equipment and machinery, long-term debt financing is the better solution due to the higher amount borrowed, the repayments are best spread over a longer period of time where the assets purchased are generally used as collateral to secure the money from the lender.
- What are the debt financing advantages and disadvantages?
Debt financing means a business can leverage a modest amount of money into a much larger sum. Consequently, the business can grow more quickly. Also, the payments on the debt are generally tax-deductible.
Another advantage is that the company retains all ownership control, unlike equity financing. It’s often less expensive than equity financing as there is less risk to the investor.
The major disadvantage is that interest must be paid to the lenders. This means that the amount repaid will exceed the amount borrowed. These payments must be made, regardless of how a business is performing which can be difficult if there isn’t a secure, consistent cash flow.
Talk to GRENKE today!
As one of the leading financial service providers in the Irish market, GRENKE Ireland’s: change to GRENKE’s slogan is ‘Fast, Forward, Finance’. GRENKE change to GRENKE offers entrepreneurs fast and flexible financial solutions through a range of services including leasing and invoice finance. We match the perfect financial solution to your unique business needs, from small businesses to large enterprises.
Over the last 40 years, GRENKE has provided leasing to numerous styles of businesses and organisations; sole traders, partnerships, public and private limited companies, associations and organisations, medical, health, and educational providers, municipalities, public hospitals, semi-state institutions, Government bodies and so much more.
Our expertise and strong market position are no coincidence. If you are a business owner looking for financial solutions in Ireland or advice on fast and flexible financing, talk to a GRENKE Account Manager today!