Running your own business might seem like a dream come true, however there’s no doubt it comes with major challenges. Finding customers, managing staff, ensuring compliance, dealing with competition, managing risk and much more – you’re dealing with demands small to large every day. Failure is common, especially for new businesses, so what can you do to give your business exactly what it needs to grow and succeed? Debt financing could drive your business forward and give it the edge it needs to stay out of trouble.
Debt financing is when your businessborrows money to be paid back with interest to run your business, and you’ll have an agreed time frame for repayment. Unlike equity financing, you’re not raising money by attracting investors who then have a stake (and claim over profits) over the business. You maintain ownership and control over your business.
You can use debt financing for any aspect of your business, whether it’s working capital or to make an acquisition. Your repayments could be monthly, half yearly, or towards the end of the loan term, depending on your agreement.
Debt finance can be secured or unsecured against an underlying asset. Examples of debt finance include bank loans, overdrafts, mortgages, credit cards and equipment leasing or hire purchase. Note that with a business, debt financing interest, fees, and charges can be claimed against your business income.
Debt financing can be short term or long term. If you’re buying things like machinery, buildings, and equipment, the loan time frame could be longer than a year (and the asset used as security for the loan). Long-term debt finance can also beappropriate if you’re employing more staff.
In contrast, short-term debt financing – such as a line of credit or credit cards – might be used for daily operations like supplies, inventory, and wages. With this type of loan you might have an agreement to repay within a year.
As with any type of debt, an element of risk is involved so it’s important to consider how much debt you can sensibly take on and review your debt-to-equity ratio.
Debt financing isamong the most popular forms of financing. So, what makes it so widely used?
While both debt and equity could help your business grow, it’s useful to consider the different implications they could have for your business.
Taking on debt means you’ll need topay back the money with interest, while equity means you’ll be sharing ownership and control. Debt won’t dilute your ownership interest. Additionally, you won’t need to share future profits of your business. As repayments and interest are more or less known in advance, you can easily plan your repayments. Debt is repaid at some point so unlike equity, it doesn’t include a permanent change to your business (ownership).
Additionally, equity is considered a high-risk investment whilst debt is considered low risk, even though equity financing means an injection of funds without loan repayment obligations. At the same time however, having a high debt-to-equity ratio could constrain your business growth because you’re paying a lot to service your debt. Another issue to consider is that debt finance is technically a loan or liability of your business. On the other hand, equity finance is technically an asset of the company, as the injection is considered the business’s own funds.
Understanding debt versus equity financing is vital when you’re exploring ways to finance your business. When weighing up one or the other, consider things like debt-equity ratio, ownership, control, repayments, and your business’s individual needs. If you’re using both types of financing, striking a balance between the two could optimise cash flow and ensure you’re getting an appropriate share of the profits.
If your business is experiencing financial difficulties, but you’re not ready to give up, consider entering voluntary administration and turning your company around. Contact our expert team and they’ll be able to help you with the next step.
Call us now on 1300 750 599.