Advantages and Disadvantages of Loans meaning Debt Financing

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Debt Financing:
Advantages and
Disadvantages

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July 2016
Index
No. Description Page No
1. Advantages of Debt Financing 3
2. Disadvantages of Debt Financing 5
3. Deciding factor 7

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Advantages of Debt Financing
• When a business use debt to finance its operation,
they got no option than to fully utilize their resources
because they will have to payback the debt and
interest to their creditor.
Proper Utilization
• Debt finance can easily be secured on a short term
bases. This make it very advantageous to the small
business as finance of this type can easily be secured
for short term business needs.
Easily Secured
• Debt financing also offers tax advantage to business
as interest is deductible for income tax purposes.
Tax Advantage
• Lenders has no direct claim on future earnings. They
are only entitled for the principal payment with interest.
No claim on Future earning

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Advantages of Debt Financing
• Debt does not dilute the ownership of your small
business.
No Ownership
• Interest and principal repayment are based on fixed
percentage and can be forecast.
Fixed Percentage
• Unlike an equity investor, a lender doesn't have an
ownership stake, so it doesn't have nor does it usually
want any say in how you run your business.
No Interference
• Raising debt capital is less complicated because the
company is not required to comply with state
and federal securities laws and regulations.
Less Complicated

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Disadvantages of Debt Financing
• As Interest is a fixed cost which raises the company's break-
even point. High interest costs during difficult financial
periods can increase the risk of insolvency.
Risk of Insolvency
• Most lenders provide severe penalties for late or
missed payments, which may include charging late
fees, taking possession of collateral, or calling the loan
due early.
Severe Penalties
• The amount of money small businesses may be able to
obtain via debt is likely to be limited, so they may need
to use other sources of financing as well.
Limited Fund
• A business that is overly dependent on debt could be
seen as ‘high risk’ by potential investors, and that could
limit access to equity financing at some point.
High Risk

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Disadvantages of Debt Financing
• Companies that are too highly leveraged (that have large
amounts of debt as compared to equity) often find it
difficult to grow because of the high cost of servicing the
debt.
High Cost of Servicing
• As it requires a small business to make regular monthly
payments of principal and interest. Because of shortage of
cash flow experience by young business it is usually difficult
to make regular payment of to creditors.
Difficulty in Regular Payment
• Debt instruments often contain restrictions on the
company's activities, preventing management from
pursuing alternative financing options and non-core
business opportunities.
Restriction in Alternative Financing
• Failure to make payments on a loan, even temporarily, can
adversely affect a small business’s credit rating and its
ability to obtain future financing.
Affect in Credit Rating

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Deciding Factor
Things to keep in mind before taking Loan
• What is the purpose of the money can be used for?
• How long you can have the money for?
• How important is it for you to retain full control of the business?
• How important is it to know precisely what you’ll owe in monthly payments?
• When do you need to repay the money
• Are you comfortable with making regular monthly payments?
• Are you able to qualify for debt financing? How is your credit history? Do you have a good
credit rating?
• Do you have collateral you can use? Are you comfortable with using it?

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