What would you do if your business is running short of funds for its daily operations? At this stage, you need to finance your business. The term “financing” refers to the process of getting funds for a company to run its business activities, purchase assets or make investments. There are two main types of financing, which are debt financing and equity financing. In today’s article, we will focus on the former.
Debt financing refers to a situation where a business borrows money from another party, and it needs to pay that amount back in the future. This means that the company gets a loan and it should repay it with interest later. The company (Also see The Records of a Company’s Resolutions and Meetings) can receive funds by using several different methods. For example, business owners can choose to get a loan from financial institutions, banks or his family members. He can also sell bonds to the public or the lenders, get cash advance by using credit cards, and so on.
Companies may decide whether they want to go for short-term debt financing or long-term debt financing. Typically, businesses that need money to fund their daily operations will opt for short-term debt financing. In most cases, this type of funding will involve a smaller amount of money, and the companies should repay it in a year. Long-term debt financing, on the other hand, is a good choice if business owners want to purchase land, buildings, large machines, equipment, and so on. By using this type of funding, the repayment terms will be longer compared to short-term debt financing.
Debt financing may bring some advantages to the business. The most significant one would be related to the company’s ownership because unlike equity financing, the lenders in debt financing will not buy the ownership of the business. This means that getting debt financing will not affect your right as the business owner as the lenders have no control over any business operation of your company.
Besides, debt financing has a longer repayment period. Therefore, it is easier for business owners to budget for their borrowings so that they can make their monthly payments. At the same time, as you need to make monthly payments over a long time if you go for long-term debt financing, this may help in building your credit score too. Having a good credit score will help your company (Also see The Importance of Company Constitution) to get funding more easily in the future if required.
Apart from the advantages that debt financing can bring to you, there are some downsides that you need to take note too. If you apply for a long-term loan from the bank, it may request for collateral from you in the event of default. If you have just started running a new business, you may not possess enough assets to be made as collateral. In this case, the lenders may want to get personal guarantees from you. Thus, if your company (Also see Calculating a Company’s Net Worth) fails to repay its debts (Also see Accounts Receivables and Bad Debts Expense) timely, you, as the business owner, need to pay for the debt.
Some of the lenders may require the borrowers to provide them with detailed business plans for them to decide whether they want to offer loans to them. Also, the interest rate for certain forms of debt financing can be quite high. Therefore, if you choose to take such types of debt financing, you need to make sure that your company can repay for it.
In conclusion, there are many types of debt financing business owners can choose from. Among all the forms of debt financing available, they may differ in terms of interest rates and repay periods, and they will bring different impact to your financial statements too. As a business owner, you need to choose the most suitable debt financing method for your business. Then, do not forget to hire an accounting services in Johor Bahru and let the professionals make the corresponding records and adjustments in your books of accounts if you do not know how to do so.