What is Debt Financing? - Free Enterprise
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What is Debt Financing?

Potential or current business owners often ask: what is debt financing? In order to illustrate the importance of that question, let us offer another one:

Besides poor management, what is the top reason why a business fails? 

  • Poor concepts?
  • Lack of advertising?
  • Down economy?

Actually, none of the above.  Inadequate or ill-timed financing, known as cash flow problems, are the second most cited reasons for business failure. If you are considering starting a business, or if your business is already up and running, debt management and cash flow demand your attention. Without sufficient capital, your business is in jeopardy. Beyond having access to financing, you need knowledge and a well executed plan to manage cash flow.  

When it comes to accessing funds, it is important to consider equity vs. debt financing as they are two significantly different financial strategies: Taking on debt means borrowing money on credit, and equity means injecting your own or other shareholders money into your company.

So, what is debt financing? Debt financing is borrowing money with the promise to return it later, in addition to interest.  Most businesses operate using debt financing. There are many different options as to debt financing and not all are the same. Different methods have various strengths and weaknesses. Some of the strengths of debt financing include tax deductions, and maintaining ownership and control of the business.  Some of the drawbacks include being obligated to repay the money, often even if the business fails, high interest rates, and potential negative impact on your credit rating.  Make sure that you look at these issues closely when you are considering equity vs. debt financing.  This post is designed to alert you to many of the options available and link you to additional resources.

Some of the ways that businesses can use debt financing: accessing personal credit, business credit, bank loans, the use of commercial finance companies, the Small Business Administration, and trade credit.

In the end, the most important thing is to understand the terms of what you are entering into. Many a business has failed because the company secured the wrong type of financing, underestimated the amount of capital required, or underestimated the cost of borrowing the money. Credit is often the lifeblood of a business, but if the debt term is too steep, even an otherwise successful business can fall too far into the red.

For more information, check out the related resources below.

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