Companies can not always finance themselves exclusively through equity . A debt financing , ie debt, which flows in from the outside, for example through loans, represents a good solution for many companies.
The benefits of additional leverage are undeniable: increased liquidity enables companies to invest more, generate higher profits, and become more and more attractive to investors.
However, the key to good debt financing is the negotiation of good conditions. Excessive interest payments reverse the profits. For investors, leverage can not be assessed as beneficial or disadvantageous for companies.
Debt financing: advantages through increased liquidity and Co.
A (partial) debt financing is useful and advisable for many companies. An example: the medium-sized software company XBase urgently needs new capital for further investments, but does not want to finance these innovations through the company’s equity. External investors (such as a bank) can step in with a cheap loan and provide fresh capital to the company.
This brings with it the following advantages for the company XBase:
1. The credit institution does not have the right to co-determine with XBase, but is only relevant for the provision of the capital.
2. The increased liquidity of the company leads to further investments, the financial leeway of XBase increase.
3. If the debt financing was concluded on favorable terms, the leverage effect can also be used. The debt is deliberately increased in order to increase the profit. The explanation: the increased capital can bring in higher returns.
4. Due to the high returns, the return on equity also increases . Many investors use this measure to determine if an investment is profitable or not.
5. The interest payable to the investor is tax deductible as operating expenses. Thus, the company does not incur any disadvantage due to the interest payment.
Disadvantages through debt financing
But also the disadvantages of this financing technique should not be underestimated:
1. The lender will always try to keep its risk as low as possible. Thus, the investor can insist on certain collateral such as the entry of a mortgage .
2. Also, the agreed interest payments must be made on a regular basis, regardless of how the company looks financially. So an interest payment can sometimes fall into a rather bad economic time.
3. Moreover, the capital is only available for a limited period, so it must be repaid at a predetermined time.
4. Even if a lender does not have the right to co-decision with its financing, the independence of a company through debt financing is never completely left untouched.
Debt financing can make sense
Whether a debt financing is really the right decision for a company depends not least on the goals and plans of a company. Because the debt financing results in various advantages and disadvantages.
For investors, debt financing is never exclusively positive or negative. For some companies, a debt financing makes sense and brings several benefits. However, it always depends on the individual situation of the company and the time.
In the interest of the company, debt financing should also only help fill financing gaps and should not be used as an all-purpose weapon. A balanced ratio of equity to debt capital benefits every company and also attracts numerous investors and investors.