Every company needs financing option; without this, the business would not have adequate money or finance to continue operating. At present, along with lending, financing option for enterprises in the public markets through the issuance of debt instruments – promissory notes and bonds are becoming increasingly developed. Debt finance is when a business chooses to borrow to get the money necessary to continue operating the finance company. Debt finance is acquired through accepting a business loan where the business owner agrees to repay the money gradually with interest rate. There are only two ways to finance company or enterprise — direct financing and debt financing. Let discuss what is Debt financing?
what is Debt financing?
Debt finance is the financing option of the current activities of the company and investment in its development not at the expense of shareholders’ contributions to the fixed (joint-stock) working capital, but at the capital expenditure of business loan, which together form the borrowed working capital. Buying a home or using a credit card is a form of debt financing. That is, you are borrowing something and you will repay it with interest rate. This is how it works. You request a business loan that you will have to return sooner or later with their respective interest rate.
The main forms of non-equity capital:
• Short-term loan or debt
• long-term loan or debt
Financing with short-term loan or debt
Financing with short-term loan or debt generally means that the lender and the borrower agree that the total amount loaned, plus interest expense, will be repaid in full within a year. Generally geared toward maintaining the company’s daily operation, short-term debt financing is commonly used to pay for equipment and to purchase any inventory or supplies vital to the company’s operation.
Long-term debt financing
Long-term debt financing is still a loan program that is requested from a bank or financial institution with the promise of repayment, plus interest expense. Rather than being used for daily business operations. Long-term debt financing is generally used to acquire a building, land, or any expensive equipment or machinery necessary to operate or expand the business. Long-term debt financing is repaid over a period of more than one year.
Net debt is a measure of financial liquidity that measures the ability of a company to pay all its debts. In other words, net debt compares a company’s total debt to its liquid asset. Net debt is the amount of debt that would remain after a company has paid off the debt with its liquid asset as much as possible. It is used to determine if a company can pay its obligations if they were all due today and if the company can take on more debt.
Net debt formula
Net debt = Short-term debt + Long-term debt – Cash and cash equivalents
The short – term debt are financial obligations due within 12 months. Common examples of short-term debt include accounts payable, short-term bank loan, lease interest payments, wages, and income taxes payable. The long – term debt is financial obligations due beyond a period of 12 months. Common examples of long-term debt include bonds, lease obligations, contingent obligations, promissory notes, and convertible bonds. Cash and cash equivalents are the most liquid asset of a company. Common examples of cash flow and cash equivalents include marketable debt security, commercial paper, treasury bills, and bank accounts. Learn also about bad credit loans.
Interpretation of net debt
Net debt is simply a company’s total debts subtracted from a company’s most liquid asset. Basically, it gives analysts and investor an idea of whether a company has a low or an over leverage. A negative net debt implies that the company has more cash and cash equivalents than its financial obligations and is, therefore, more financially stable. However, the debt metric should not be used only to determine a company’s financial management health. It should be used in conjunction with other liquidity and leverage ratios, such as the current ratio, the quick ratio, the debt ratio, the debt-equity ratio, etc.
Net Debt (Net Cash)
Businesses that have little or no debt will often have a negative net debt (or positive net cash) position. A negative amount indicates that a business has enough cash and cash equivalents to pay its short and long-term debt and still has excess cash flow. Net Debt is used to measure the financial stability of a company and gives analysts and investor an indication of a company’s leverage. Businesses with negative net debt are generally in a better position to withstand adverse economic changes, volatile interest rates, and recessions. As it can be a useful indicator of financial health, investor use it to determine whether to buy or sell a company’s shares. However, it must be used in conjunction with other financial reasons to provide an accurate representation of a company’s financial health.
Benefits of debt financing
The benefits of debt financing are many. The most important is that it is one of the only ways to get quick money for your business without losing any property. When you choose debt financing, you retain your ownership privileges over your business, and the lender never intervenes in the business and that the interest expense generated can be made tax-deductible. In addition, it is easy to forecast payments as they do not vary. Debt financing allows you to pay for new buildings, equipment, and other asset used to grow your business before earning the necessary funds. The second great advantage is that debt financing loan program are tax-deductible. By considering the secured loan as an expense, you can eliminate your payments and interest payments from the company’s income tax.
The most obvious downside to debt financing is that you have to repay the loan program plus interest. Failure to do so exposes your property and asset to bank repossession. There are so many economic factors that you do not know if you will not have the payment and interest payments on time which puts the finance company and its capacity for growth at credit risk. Debt financing also involves borrowing based on future earnings. This means that instead of using all your future earnings to grow the business or to pay the owners, you have to distribute a portion for the debt payments. Overusing debt can severely limit future cash flow and stagnate growth.
Tips for managing your company’s debts;
Here are some tips about managing your company debts;
Know the total value of your debts;
The ideal is to list all debts in order of delay and urgency of payment. The priority should be the accounts that have the highest interest rate, as is the case with credit cards and overdrafts.
Set a monthly savings target
After defining a strategy to pay off the most urgent debts, you can adopt a practice to avoid resorting to more expensive loan lines. So, when you have more balanced debts, try to define what expenses you can cut to save.
Negotiate with creditors
After knowing the size of your debt and being able to identify your monthly payment capacity, it is much easier to negotiate the most expensive and oldest debts with the credit rating institutions. Before making this contact, set a limit on how much you can allocate to debts. and check in your budget if the amount suggested by the operator is in accordance with what you have defined.
Exchange expensive debts for cheaper ones
If negotiations with creditors do not evolve, you can move on to credit rating portability. In this case, the consumer can look for an institution that offers better payment terms and transfer the debt.
Control your spending
All of these tips only work when the consumer adopts new consumption habits. This does not mean that he should stop consuming, but make a commitment to himself to get out of debt and create stricter finance goals with his money.
Record all expenses
The best way to control the budget is to write down all expenses by Using a notebook or spreadsheet. In this way, it is possible to identify your finance profile more clearly, as well as understand which are the focal points that are impacting your financial health?
Seek more knowledge about financial education
One of the main ways to get out of debt is to have the knowledge to avoid it. For this reason, it is essential that you seek knowledge on how to educate yourself financially.
Get extra income
If the accounts got out of hand, getting more resources to pay them off is an interesting path. Today, many people undertake to prepare goodies to sell at work, driving through apps, and exercising various activities outside fixed hours.
Beware of installments
Installment is a facility, as it allows the purchase of high-value products that, if they were bought in cash, would consume a good part of the monthly budget. But the plots that you lose sight of can also be negative in your attempt to get out of debt.