Major Benefits of Debt Financing for a Business

"Explore the significant advantages of debt financing for businesses. Understand how this funding method can support growth, investment, and financial stability."

Major Benefits of Debt Financing for a Business

Published: 8 June 2022

Updated: 13 May 2024

In today’s era of fast-paced business environments, the secret to growth for small businesses lies in making quick and smart decisions at the right time. While doing so, you can face the hurdle of getting quicker access to capital. This is particularly true for small and medium businesses that don’t usually possess a huge sum of money at one point in time. This is where debt financing emerges as the best solution for them to meet their financial needs. In this blog, let’s get to know about what debt financing is and why it is beneficial for small businesses.

What is Debt Financing?

Debt financing refers to the process of borrowing funds to run a business. This type of financing is very different from equity financing, which involves raising funds from investors who in return get a share of the profits from your business. There are basically two categories of debt financing that depend on the type of loan a businessman wants – short-term or long-term.

Long-term Debt Financing

Long-term debt financing is typically used to finance assets that your company is acquiring, such as equipment, buildings, land, or machinery. 

Long-term loans are often secured in nature, and borrowers have to provide security as assets to the lender. The loan repayment schedule and the expected usable life of the assets are frequently extended for three to seven years using long-term debt financing. SBA-guaranteed loans can have maturities of up to ten years.

Long-term debt will almost certainly have fixed interest rates, resulting in consistent monthly payments and a high degree of predictability.

Short-term Debt Financing

Short-term debt financing typically refers to a finance scenario when the money is needed for day-to-day business activities, such as purchasing stock, paying monthly salary, and others.

Short-term financing can also be defined as a working loan or a short-term loan as scheduled repayment needs to be done within a year. For example, A line of credit can be defined as a kind of short-term debt financing.

Short-term financing is commonly used by businesses that tend to have temporary cash flow issues when sales revenues are insufficient to cover current expenses. Start-up businesses are particularly prone to cash flow management problems.

Debt financing is a quicker and more effective way for businesses to raise funds for various purposes like hiring a workforce, expanding a business, buying property or equipment, etc.

There are different options for debt financing including small business credit cards, merchant cash advances, and business loans. Although each form has perks, a person should be confident about how much they require before applying for any of them. As an outcome, it is critical to thoroughly explore your alternatives before deciding on the best one for you.

Debt Financing Tool

Some common types of debt financing tools are:

  • Conventional bank loans
  • Home equity loans
  • Personal loans
  • Public loans like Small Business Administration (SBA) loans
  • Peer-to-peer loans
  • Lines of credit
  • Loans from family or friends
  • Real estate loans
  • Credit cards
  • Equipment loans

Benefits of Debt Financing For Business

The biggest benefit of debt financing is that the lender or creditor is not entitled to capture an equity position in a business. The owner remains the whole sole owner and the lender doesn’t have any role to play in day-to-day business operations. In contrast, if you give up equity in the form of shares in return for capital, you may be dissatisfied with outsiders' opinions on your company's future.

Debt interest is entirely tax-deductible as business overhead. In the case of long-term financing, the repayment time can be protracted over several years, thereby controlling the monthly expense. Considering that the loan has a fixed interest rate, the interest expenditure is a predictable amount for budgeting and business planning.

Quick to Get Funds

Finding good investors for your business might take some time. However, if you simply match the business loan eligibility criteria and want urgent money to handle your working capital or day-to-day expenditures, a business loan is truly a smart option.

Lower Interest Rates

When interest rates are sky-high, credit cards, peer-to-peer lending, short-term loans, and other debt financing choices are useless.

When compared to regular business loans, these loans typically have extraordinarily high interest rates. Simply test the effect of your selections on your overall interest outlay.

Easy Financing

When you have a clear idea about how much principal and interest you are supposed to pay each month, it is easier to organize your monthly budget. If there is an unsecured business loan, you can simply use a business loan EMI calculator to determine your monthly outgo.

Ideal for businesses of all types

Alternative fundraising tactics may not be available to all companies. For example, venture investors routinely overlook multiple tiny firms in their pursuit of the next big 'unicorn,' despite the fact that generating and issuing bonds is a difficult procedure at best. Debt financing, on the other hand, is a simple choice for firms of all sizes.

Can help in improving the credit score of businesses

If you manage to pay all your EMI payments on time, it helps in adding up to and improving your credit score. This, thereby, enables you to easily access funds in the future when you may require them again.

Moreover, a good credit score displays to lenders and vendors alike that you are a responsible business owner and that the cash flow of your business is enough to meet all its obligations.

Debt vs. Equity Financing – Which is Better?

Taking on debt entails repaying the money with interest, whereas equity entails sharing ownership and control. Your ownership interest will not be diluted by debt. Furthermore, you will not be required to share your

 company's future profits. You can conveniently arrange your repayments because repayments and interest are known in advance. Debt, unlike equity, is repaid at some time and does not result in a lasting impact on your firm (ownership).

Furthermore, equity is regarded as a high-risk investment, whereas debt is regarded as low-risk, despite the fact that equity financing involves an infusion of capital with no loan payback requirements. At the same time, a high debt-to-equity ratio may limit your business's development because you're spending a lot to service your debt. Another consideration is that debt finance is technically a loan or liability of your company. Equity financing, on the other hand, is theoretically a corporate asset because the infusion is deemed the firm's own cash.

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