What is Debt Financing: EXPLAINED
By Article Posted by Staff Contributor
The estimated reading time for this post is 170 seconds
Debt financing is the second component of the weighted average cost of capital (WACC). If you are an entrepreneur and you are looking for funding, chances are you have come across these two terms:
- Debt financing
- Equity financing
Since we’ve talked about equity financing in another article, we will focus on debt financing in this post. So, in simple terms, debt financing means borrowing money from financial institutions, typically commercial banks, to acquire assets or invest in working capital.
So, what are the advantages of debt financing in comparison to equity financing, or ”Why would you choose debt financing over equity financing?”
- Maintaining ownership of the shares in contrast to equity financing, you would need to sell off some of your shares in exchange for capital.
- The interest paid from the loan made is tax-deductible, whereas dividends are paid from profits after tax.
- Debt financing is believed to be relatively cheaper than equity financing as the interest rate is lower than the shareholder’s return.
With all these advantages, there are also disadvantages to debt financing. These disadvantages are:
- In case of default, the banks will take over all the assets.
- Higher debts would lead to high interests expense, lowering the shareholder’s profits.
Ultimately, if you are looking to fund your business through debt financing, always remember to keep it at a reasonable level as too much debt financing may lead to default.
With that being said, let’s take a look at the different sources of debt financing.
Types of Debt Financing
1.Bank Loans
Bank loans are commercial loans made to a corporation where the company’s assets will be used as collateral for the loan. Bank loans are offered by commercial banks and offered by various financial institutions and commercial lenders.
Although it is hard to get a bank loan as they have strict requirements to get them, if you qualify for the loan type, bank loans charge a low-interest rate. So, bank loans are a good option if you are looking to get a large funding sum.
2.SBA (Small Business Administration) Loans
If you have a small business, then you may want to consider getting an SBA loan. SBA loan is basically a loan for small businesses partially guaranteed by the government, reducing the risk of financial institutions issuing out the loan.
As a small business, you may want to go for SBA loans because they are known to offer interest rates that are very low and repayment terms favorable to business owners. Additionally, the collateral is also lower in comparison to traditional bank loans.
The only downside is that the application process for SBA loans may take longer.
Conclusion
When you are looking to fund your company through debt financing, understand your company’s current position. As ultimately, you want to use the advantages that debt financing has to offer in your favor. However, always remember that debt financing is efficient only if kept at a reasonable rate as you want to avoid defaulting.
Although there are many different types of debt financing, the two main ways to do so are through traditional bank loans and SBA loans. These 2 types of loans charge a low-interest rate, which is suitable when you are looking to grow your business. However, if your business is new, you may want to consider for SBA loans as it provides better terms in comparison to traditional bank loans
RELATED ARTICLES
Saving vs. Investing: What’s the Difference?
The estimated reading time for this post is 173 seconds When managing your finances, two terms often pop up: saving and investing. But what’s the difference, and how do you decide which one’s right for you? Understanding these concepts can...
Exploring the Financial Challenges of the Unbanked: Insights from the FDIC’s 2023 Survey
The estimated reading time for this post is 266 seconds Introduction In 2023, about 4.2% of U.S. households—equivalent to approximately 5.6 million families—remained unbanked. Despite years of economic growth and increased financial services accessibility, millions of Americans continue to operate...
1 Comment
Leave Comment
Cancel reply
Saving vs. Investing: What’s the Difference?
Exploring the Financial Challenges of the Unbanked: Insights from the FDIC’s 2023 Survey
Should You Rent vs Buy a Home? How to Decide.
Gig Economy
American Middle Class / Nov 24, 2024
Saving vs. Investing: What’s the Difference?
The estimated reading time for this post is 173 seconds When managing your finances, two terms often pop up: saving and investing. But what’s the difference,...
By Article Posted by Staff Contributor
American Middle Class / Nov 15, 2024
Exploring the Financial Challenges of the Unbanked: Insights from the FDIC’s 2023 Survey
The estimated reading time for this post is 266 seconds Introduction In 2023, about 4.2% of U.S. households—equivalent to approximately 5.6 million families—remained unbanked. Despite years...
By FMC Editorial Team
American Middle Class / Nov 09, 2024
Should You Rent vs Buy a Home? How to Decide.
The estimated reading time for this post is 327 seconds The question of whether to rent or buy a home has been overanalyzed by just about...
By MacKenzy Pierre
American Middle Class / Nov 05, 2024
Creating an Emergency Fund: Why Everyone Needs One and How to Build It Quickly
The estimated reading time for this post is 331 seconds Introduction: The Safety Net You Can’t Afford to Ignore Life is full of unexpected events—whether it’s...
By Article Posted by Staff Contributor
American Middle Class / Nov 02, 2024
2025 401(k) limit: $23,500; IRA limit unchanged
The estimated reading time for this post is 191 seconds Maximize Your Retirement Savings in 2024: Key IRS Adjustments to Know Saving for retirement just got...
By Article Posted by Staff Contributor
American Middle Class / Oct 30, 2024
US Economy Update
The estimated reading time for this post is 139 seconds The Bureau of Economic Analysis (BEA) report indicates solid economic growth in the third quarter of...
By FMC Editorial Team
American Middle Class / Oct 29, 2024
Zero-Based Budgeting: A Guide on Tracking Every Dollar to Maximize Savings
The estimated reading time for this post is 324 seconds Introduction: Why Zero-Based Budgeting? Have you ever gotten to the end of the month and wondered...
By Article Posted by Staff Contributor
American Middle Class / Oct 26, 2024
10 Credit Cards with the Highest Annual Percentage Rates (APR) on Purchases and Cash Advances
The estimated reading time for this post is 362 seconds When you’re on the hunt for a credit card, there are many things to consider—the rewards...
By Article Posted by Staff Contributor
American Middle Class / Oct 18, 2024
The Hidden Costs of Financial Procrastination
The estimated reading time for this post is 354 seconds You might think delaying your financial decisions isn’t a big deal. But let me tell you,...
By Article Posted by Staff Contributor
American Middle Class / Oct 17, 2024
What to Do If You Are Underwater on Your Car Loan
The estimated reading time for this post is 386 seconds Being underwater on your car loan can feel like you’re sinking financially, but you’re not alone....
By MacKenzy Pierre
Latest Reviews
American Middle Class / Nov 24, 2024
Saving vs. Investing: What’s the Difference?
The estimated reading time for this post is 173 seconds When managing your finances, two...
American Middle Class / Nov 15, 2024
Exploring the Financial Challenges of the Unbanked: Insights from the FDIC’s 2023 Survey
The estimated reading time for this post is 266 seconds Introduction In 2023, about 4.2%...
American Middle Class / Nov 09, 2024
Should You Rent vs Buy a Home? How to Decide.
The estimated reading time for this post is 327 seconds The question of whether to...
Pingback: What is equity financing? EXPLAINED - Finance - FMC