When a company borrows money with interest to repay at a future date, it is known as loan financing. Loan financing can be in the form of a secured and unsecured loan. A firm borrows either to get finance or obtain working capital. You can also understand standing order vs. direct debit as they are also important payment mechanisms that can provide easy payments.

Direct Debt

Debt means the amount of money that needs to be repaid, and financing means providing funds for business activities. An essential feature of debt financing is that you are not losing ownership of the company. Debt financing is a time-bound activity where the borrower must repay the loan with interest at the end of the contract. Payments can be made monthly, half-yearly, or until the end of the loan term.

Features

An essential feature of loan financing is that the loan is secured with the assets of the borrowing company, or it is attacked. This is usually part of a secured loan. If the loan is unsecured, the credit line is generally short. If a company needs a large loan, then loan financing is used, where the owner of the company adds some of the firm’s assets, and the loan is given based on the value of those assets.

Downsides

Debt financing is an expensive way to raise funds, as the company has to involve an investment banker who can form large loans in an organized manner. This is a viable option when the cost of interest is lower, and the return is better. A company goes through debt financing because it does not have to invest its capital. But too much debt is also a risk, and thus, companies have to decide on a level (debt to equity ratio) from which they feel comfortable.

Posted by Jack J. Young

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