Funds are necessary to start and run any business. When you go for external sources of finance, you have many options – debt financing being one of them. You take business loans from banks or private non-banking financial corporations (NBFCs) to finance your business with debt financing.
What is debt financing?
There are several types of debt financing. They include small business credit cards, merchant cash advances, Term Loans, and small business loans. Each type has its advantages, and you have to be sure of how much you need before applying for any. Therefore, be sure to research your options well before choosing the one, which is best for you.
Advantages of debt financing
There are many advantages to debt financing, from retaining control of your company to tax benefits. Here are the top six:
- Ownership stays with you.
When you borrow money from a financial institution, you are obligated to pay them back the principal amount along with a pre-decided interest. They do not have a say in how you run your business, unlike venture capitalists. Therefore, you retain the ownership of your company and are free to make decisions at your discretion.
- Tax deductions
Since the payments made to repay a loan can be counted as business expenses, they are tax-deductible. This reduces your net tax obligation at the end of the year.
- Lower Interest rates
The tax deductions can lower your interest rates. Simply check the impact of the deductions on your bank interest rates. So, for example, if the lender charges you 10% and the government taxes you at 30%, there is an advantage to taking a loan you can deduct.
- Easier planning
When you know exactly how much principal and interest you have to pay every month, it becomes much easier to plan out your budget for each month.
Additional Read: Why every SME needs a solid financial plan?
- Accessible to businesses of any size
Alternate methods to raise finance may not be accessible to small businesses. For example, venture capitalists often discount a majority of small businesses in their search for the next ‘unicorn’, and creating an issuing bond is a complicated process at best. Debt finance, however, is an easy and accessible option for businesses of all sizes.
- Builds (improves) business credit score
When you make your EMI payments on time, it adds to and improves your credit score. This, in turn, enables you to easily access funds in the future when you may need them again.
Additional read: What is the importance of your business credit score?
Moreover, a good credit score shows vendors and lenders alike that you are a responsible business owner and that your business’s cash flow is enough to meet its obligations.
Types of debt financing
Some common types of debt financing include:
- Bank loans: Businesses obtain loans from banks by agreeing to repay the borrowed amount along with interest over a designated period.
- Corporate bonds: Companies issue bonds to raise funds from investors, promising to repay the principal amount with interest at a predetermined future date.
- Non-Banking Financial Companies (NBFC) Loans: These are loans provided by entities other than banks, offering various lending options to businesses.
- Public deposits: Businesses raise funds through public deposits where individuals and organisations lend money to the company for a fixed period at a specified interest rate.
- Debentures: These are debt instruments issued by companies that acknowledge a specific amount of loan, which must be repaid at a defined future date, often with a fixed rate of interest.
- Trade credit: Businesses acquire goods and services on credit terms from suppliers, allowing them to make payments at a later agreed-upon date.
Debt finance is, therefore, an excellent option to try for when you require funds. However, be sure that you can repay the amount you borrow. Once you are sure, you can go ahead with your borrowing plans.