Acquiring money for funding a company through the use of debts is termed as debt financing. Most of the small scale companies depend on debts for their investments. Some of the large scale companies also use this method from time to time. The source for these debts is usually but not limited to a bank. It can also be other financiers who lend money for a particular percent of interest.
When you borrow money from a bank or a finance company, you will be needed to repay the money after a period of time. But, your company is not involved in this debt and so you are free to choose your method of business. It implies that the circle of the loaner’s control over your rights does not include your company. This is the main advantage of using debt financing.
The amount of money that you have loaned from others and the money that you pay as interest are classified as company expenses. Thus you can enjoy tax exemptions for this money. Now, consider that the government applies 30 percent tax on your income and if you pay this money as interest for debts, you will pay about 10 percent as interest and can be exempted from paying 30 percent to the government. So, in a way, you will lose less money if your funds come through debts.
You can lend money only up to a certain extent. Generally, when the amount of money that you borrow becomes more, the interest rates will also increase. All your profits in business will go towards paying the interest and you will find it difficult to continue with the business.
Also, some loaners offer money with a very small repayment time. You must plan your investments carefully and before you borrow money, you must make sure that you will be able to generate the funds required to repay the debt within the repayment time. There is no point in borrowing money if you are not able to generate more money than that you borrowed.
Although debt financing saves you a lot, you will still have to repay the debt. So, instead of relying on debts, you can try out other alternatives like equity financing. In spite of all of its ill effects, if you are still confident that you will be able to profit through debt financing, then you should proceed with your plan.