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Financing your Business : Debt Financing

F for Finance

Series of articles giving deep insights about sourcing and getting finance for business.

Debt Financing

The last articles threw some light on pros and cons of “Bootstrapping”, as the first and foremost option of financing your business. Bootstrapping is the best option for services oriented or small scale businesses. However the moment the business requires innovation, marketing & promotion activities the owned funds fall short.

Another most traditional way of funding your business is through “Debt”. The Debt Financing or raising money through Debt comes with a cost, i.e; interest.  Banks are the primary source of financing loan for business.

Bank loans for business come in varied categories depending upon the stage and size of business entity. Banks primarily divide the business based on turnover i.e; annual sales, the quantum of loan and the share capital infused in the company.

Small businesses’ are mostly manufacturing units wherein the turnover is less than Rs.50 crore and the amount of loan is also less. The services industry is also categorised into small businesses’ wherein the sales is through fee income.

Debt financing is done against security of equivalent or higher than the loan amount. The Bank’s or financial institutions ask for Primary and collateral security in the form of hypothecation & mortgage of fixed assets.  Debt financing is suitable for manufacturing units or those who have fixed assets like Land & Building, residential or commercial premises in their name, factory equipments & machineries etc.

The financing comes in two ways, viz, short term for working capital requirements and long term for setting up project or factory. The working capital funds are used for managing day to day operations of the company.

Now consider a start up who is involved in building a technology related product or mobile application. The start up surely not going to deploy any machineries and assuming not backed up any fixed assets in his/her name , would find it impossible to go for Debt financing through Banks of any other financial institutions.

Further the rates of interest charged by the Banks/FI’s are on higher side payable on monthly basis. The start up which is at the initiation stage may not be able to take the fixed monthly burden of payment every month. This is another reason the start ups are reluctant to go for traditional way of funding their start up through Bank financing.

It may be noted here that, the scope and scale of business operations play the most important role in deciding the way of funding your business.  Select the best option depending upon your requirement. Take the right call at the right time.