Debt Financing Definition:
What is debt financing? When a company / firm / business raises fund that you get to maintain your business operations is known as debt financing. This fund is raised by offering debt instruments to individuals or investors. In return an organization or business give creditors a guarantee note stating to payback principal plus interest on the debt within a specified period of time.
It includes both unsecured and secured loans. Security includes a type of pledge / bond / asset as an assurance that loan will be paid with interest. In case of debtor getting defaulter on the repayment terms then the security is sold / surrendered to fulfill installment of the debt. Lenders mostly ask for security on the loans. In few case like brand or reputed goodwill, lender may give you loan on your name alone.
Debt finance is broadly divided in to three types of categories:
- Short Term (Secured / Unsecured) Loans – usually repaid within 6 – 12 months term period.
- Intermediate Term (Secured / Unsecured) Loans – usually repaid within 3 years term period.
- Long Term (Secured / Unsecured) Loans – usually repaid within 5 years term period.
Debt Financing Example:
Debt Financing Example-1: Let us take an example of debt financing from a Coffee shop which is owned by Jeff. He has been doing business for a long time. Throughout the most recent couple of months, Dennis considers growing his business. Along these lines, he meets with a credit officer in the bank to talk about debt financing.
Jeff was given an offer by loan officer to gets INR 100,000 for a long time at 8.75% interest on principal. This concludes that Jeff has to pay INR 15,039 every year till 10 years. To secure the credit, the loan officer requests that Jeff should provide the coffee shop asset papers as guarantee in case if Jeff fails to payback the amount with interest.
Debt Financing is a costly method for raising cash. On the fact that the organization include a third party in the condition and structure a high credit extension deliberately to back its operations. Then again, it’s the best way to leverage your business to raise fund without utilizing own funds.
Debt Financing Example-2: Assume that company XYZ has issued a bonds as debt financing option. A bond promise to its bondholder a payment Rs.100,000 every year on 1st April for the next 20 years. In addition, bondholder have rights to sell the bond at any time before maturity period. To get the benefits and privilege, bondholder need to make a whole lump-sum payment at the time of buying bonds from the issuing company. Usually company prepares this option for financing because Interest rates on bonds are lower as compare to bank loans.
Here we have understood the debt financing definition along with debt financing examples. Debt financing can be in the form of either secured finance or unsecured finance. This depends on the purpose for which company decide to go for debt financing.
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