What is debt financing?
Debt financing is a way of financing businesses, using foreign capital. It stands out with two big pluses.
- First: using debt financing, we do not have to commit our own resources to the development of the company.
- Second: with debt financing, you don’t cede control of your company to investors or shareholders – so if the product you create turns out to be revolutionary and lucrative, you will retain 100% ownership.
Of course, debt financing has its drawbacks – unlike equity financing, funds raised from debt must be repaid, usually with not inconsiderable interest. Thus, in case of failure of the idea or further financial problems of the company, we may be left without the expected earnings, but with debts to pay. Therefore, it is worth making the decision to finance a start-up with foreign capital after careful consideration of all the “pros” and “cons.”
However, before it’s time to choose, it’s a good idea to learn a little more about debt financing. For example.
Debt financing – examples
We can obtain funds for business development from various sources. Among the most popular ways are:
- bank loans
- factoring
- lease
- trade credits
We will discuss them in detail to help you choose the right form of financing for your business.
Bank loan – the most popular, but subject to conditions
This is by far the most frequently cited form of corporate financing. Its popularity comes from an extremely wide range of offers – we have a lot of banks offering loans in Poland, their offers compete with each other, so that an entrepreneur who wants to take out a loan faces a real disaster of birth.
But don’t forget that choosing the best loan offer isn’t even the first step – because nothing in the loan process will happen without a positive assessment of the company’s finances. So if you want to finance your company through a bank loan, be prepared to fill out a detailed application, vet your company’s liquidity, wait a relatively long time for a credit decision, and be prepared to secure the loan (such as a surety or promissory note). Remember, too, that the cost of debt financing in the form of a loan will be higher the longer the repayment period you choose.
What purposes can you use the bank’s loan for?
- Projects and investments;
- Current operations;
- Purchase of machinery, equipment, cars.
A bank loan in a nutshell – many offers available, security of the transaction, but also difficult credit for companies with not much seniority, a protracted wait for a credit decision and a lot of paperwork.
Factoring – a flexible and fast solution
Although less popular than loans, factoring is finding a wider and wider audience, with more companies opting for financing with the help of factoring every year. The big advantage of this service is that it does not put the company into debt – factoring is about cashing in receivables, not borrowing money.
So if you need money, you can report the recipients you invoice on the invoice factoring site, PragmaGO. After filling out a short form, you will receive the terms of the contract. After their approval and signing of the said agreement, you will be able to conveniently submit invoices for financing through a special Customer Zone.
What are the biggest advantages of factoring?
- You don’t put the company into debt;
- You speed up the receipt of funds that are due to your company anyway;
- You have a choice of permanent sales financing, i.e. online factoring, or financing from time to time, i.e. invoice financing service.
Remember, however, that you will pay for factoring in the form of a factoring commission. In addition, if you opt for incomplete factoring and it is up to you to ensure that the payee repays the obligation, you will also pay interest if your counterparty is late in paying.
Also find out how factoring differs from credit.
Operating leases – a good way to get company equipment
Usually leasing is associated with cars, and indeed – it is most often cars that Polish entrepreneurs lease. Beyond that, however, this method of financing can be used to spin up an ice cream shop or open a restaurant – we can lease almost any equipment or machine. Of course, in the end you will pay more for the product, but you will be able to spread the payment into convenient installments, and include the cost of these installments in your business expenses, thus reducing the amount of your tax base.
An operating lease is actually the granting to the lessee of the right to use a fixed asset with an optional buyout after all lease payments have been paid. This is a good opportunity for companies with little seniority to gain access to professional equipment – after a few years of verification, the entrepreneur can buy the leased item or return it to the lessor.
What should you keep in mind when taking an operating lease?
- Lease installments will be included in company expenses;
- After paying off the installments, we can buy back the leased equipment;
- The depreciation allowance is used by the employer the security of the lease agreement is usually the leased object – this means that failure to pay the installments on time will end in the repossession of the object and optional penalties, the agreement says.
Learn more about the differences between factoring and leasing!
Trade credit – a simple agreement with the seller
With a trade credit we can finance a transaction with a specific seller, since in this option it is the seller who extends credit to the buyer. In practice, trade credit often equates to deferred payment, possibly installment sales.
A big advantage of trade credit is usually low cost and few formalities – all that is needed is actually a contract written between the seller and buyer, in which the parties include information on the repayment term or possible interest.
Important!
If the store does not offer trade credit, but its product range and prices are attractive enough that you still want to make your business purchases right there, there is a possibility: PragmaGO purchase financing. All you have to do is order the products you need, submit the order to the factor and choose deferred payment or installments, and PragmaGO will pay your order by instant transfer. In return, you commit to repaying the installments on specified dates.
What are the distinctive features of trade credit?
- Credit without an intermediary, based on a contract between the seller and the buyer;
- Low cost compared to a bank loan or credit;
- There are usually at least a few installment options available.
Debt financing costs
One of the advantages of debt financing is that the costs associated with it can be recognized as a cost of doing business. It is worth remembering, however, that we cannot do this indefinitely – according to Art. 15c of the CIT Law, taxpayers must exclude from deductible expenses a portion of debt financing costs. Specifically, the part where the surplus exceeds 30% of EBIDTA. For more information, see the aforementioned Corporate Income Tax Law.
