What is debt?
Debt encompasses funds borrowed from external sources to support or expand business activities. In contrast to equity, where company shares are sold to investors, debt consists of obligations that must be repaid.
What types of debt are there?
Bank loans: These are loans granted to companies by banks, and can be long-term, such as mortgages for real estate, or short-term, like operating loans.
Bonds: Companies can issue bonds that are purchased by investors. These bonds have a fixed interest rate and a set term. At the end of the term, companies repay the borrowed capital.
Leasing: Companies can lease assets such as machinery or vehicles instead of purchasing them. This is a form of debt financing where monthly payments are made to enable the use of the asset. s
Supplier credits: Suppliers can extend credit to companies by extending payment terms for delivered goods or services. This can improve a company's liquidity.
Why is debt important?
Leverage: By using debt, companies can preserve their equity and use it for other investments or emergencies.
Tax benefits: Interest payments on debt can be tax-deductible in many countries, reducing a company's tax burden.
Flexibility: Companies can adjust the type and amount of debt according to their financing needs.
Facilitating growth: Startups can grow faster and scale their business models by taking on debt.
What are the risks of debt?
Interest and repayment: Interest and borrowed capital must be repaid regardless of business success.
Overleveraging: Too much debt can lead to high levels of leverage and jeopardize financial stability.
Credit checks: Lenders conduct credit checks and often require collateral, which can be challenging for startups with limited assets.
Interest rate fluctuations: Fluctuations in interest rates can increase the costs of debt and affect profitability.
How should debt be used?
The use of debt requires careful planning and risk assessment. Companies should:
- Clearly define their financial needs.
- Select the best financing options.
- Ensure that the interest rates are manageable.
- Implement effective debt management.
- Consider the impact on the balance sheet and cash flow.
Conclusion
Debt is an important resource that companies can use to finance their growth. It presents opportunities but also risks that must be carefully weighed to ensure a healthy financial foundation.