When it comes to raising the required funds for your small business, there's a range of credit options to consider. Depending on your business model and needs, you will require different types of funding, and debt financing may be one of them.
What is debt financing?
Debt financing refers to a loan obtained from external sources with interest added. This type of funding, which essentially causes a business to be indebted to their loan provider, is an extremely common option for start-ups and small businesses.
What are examples of debt financing?
Debt financing includes products such as:
- Lines of credit from banks or financial institutions (overdraft facility, credit card, business loan)
- Hire purchase
- Trade credit
- Commercial bill
- Invoice finance
What's the most popular type of debt financing?
According to the Reserve Bank, three quarters of debt financing for small businesses are sourced from banks, followed by just over one-quarter from finance companies for products such as leasing, vehicle and equipment loans. The most popular finance products are credit cards, secured bank loans and overdrafts.
What are the pros and cons of debt financing?
The advantage to debt financing is that the lender usually doesn't have a say in how your business is run. Furthermore, once you have paid off your loan, there are no further obligations to the bank.
According to Investopedia, it's also easier to forecast expenses because loan payments do not fluctuate. However, if these payments are not made on-time or at all, the repercussions can be severe - in the worst-case scenario, out-of-control debt can result in strained cash flow and business failure.
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