#commerce/y9/business
- Debt is borrowing from other individuals or institutions (eg. a loan from a bank).
- Application for a loan required good credit rating (history of repaying debt on time).
- The lender needs to be assured that the borrower can repay on time.
Types of debt financing §
- Bank loans: when a bank offers to lend money to consumers for a certain time period. As a condition of the bank loan, the borrower will need to pay a certain amount of interest per month, or per year.
- Overdrafts: allows you to access extra funds through your account to an approved limit, avoiding fees. Interest is only charged on the amount overdrawn.
- Mortgages: A bank lends money at interest in exchange for taking title of property.
- Credit cards: provides access to funds up to a certain limit, so long as you make the minimum payment by the due date each month.
- Equipment leasing and hire purchase: in a lease, ownership lies with the lessor. The lessee has the right to use the equipment and does not have the option to purchase. Whereas in hire purchase, the hirer has the option to purchase. The hirer becomes the owner of the asset / equipment immediately after the last instalment is paid.
| Advantages of Debt Finance | Disadvantages of Debt Finance |
|---|
| Interests are tax deductible | Fixed repayment is necessary regardless of the performance situation |
| Profit does not have to be distributed | Interest can be costly (especially when interest rates are rising) |
| Owners retain control of the business operation | Good Credit rating is required |
| Easier to budget and calculate the expected cash flow | Banks might need security of certain assets (ie. the bank owns it until the loan has been repaid) |