There's a stigma associated with the word debt that makes business owners panic and run in the opposite direction upon hearing it. However, if the stigma is taken away, debt can be strategically used to the business owner's advantage.
Businesses need capital to finance day-to-day operational needs or to make large purchases, and they may need to obtain such funds from an external source. Optimally using external funds as debt can help businesses sustain and scale operations in the long run.
Circumstances where entrepreneurs can use debt financing:
For growing business: Debt financing is more feasible as growing companies need a consistent flow of capital. Debt financing is less expensive as the interest payments that companies make on debt is tax-deductible. Additionally, debt financing is more viable as companies can use it and make interest payments when they have good cash flow periods.
Short-Term Financing: Another situation in which companies can use debt is for their short-term financing needs. Short-term debt financing is paid off in a short period and can be used to finance a firm's short-term working capital needs like liquidating accounts receivable or procuring additional inventory.
Company control: Debt financing is used when the business owner wants to retain the company's control rather than raising equity and giving up a stake in the business.
The majority of large corporations have some level of debt which can be a great way for business owners to optimise funds and earn optimal returns on their investment. Debt has become an integral part of the engine that drives economies worldwide. With Tata Capital business loans, companies can usher in ample funds to expand the business, boost production, buy new machinery, and deepen market penetration.
Debt can help a business thrive, and here are some of the tips for using debt to fuel business growth -
Lower Financing Cost
The cost of Debt financing is lower when compared to equity. Debt is finite, and the business owner is contractually liable to make periodic interest payments and return debt principal within the fixed period. On the other hand, equity is infinite where the business owner sells a stake in the company and is obligated to share some of the company's profit to the equity holder forever.
For example, when a company is making 30 lakhs a year, the owner would rather pay three lakhs in interest for a limited period than give up 10% of the company's profits forever. However, for the cost-benefit analysis to be favourable towards debt, the cost of debt financing must be nominal.
Improved Tax Savings
The cost of debt is less than the interest rate given the tax benefits it offers, as interest payments are tax-deductible.
For example, if the interest rate is 5% on debt finance and the business tax is 20%, then the cost of debt is only 4% which is a significant tax saving.
Debt helps lower a company's tax obligations due to allowable interest deductions. As per rules, interest payments are considered as expense deductions against revenues before calculating taxable income. Low taxable income is always better for the company, and tax savings help further reduce a company's debt financing cost.
Build Credit Score
If a business owner has never taken a loan, then the owner has no credit score or report. This presents a problem to most lenders, and they might not approve a loan or company credit card due to a lack of payment track record to make a lending decision.
The credit score serves as a simple tool for lenders to understand if the business owner meets the lender's requirements. With debt financing, the business owner can build a good repayment track record by taking a loan and paying interest on time.
Take on additional business
Several businesses stagnate upon reaching a particular stage of maturity due to a lack of access to cost-effective funds to take on new orders and fulfil them. Getting a business loan can help accelerate growth by giving business owners the confidence to take up more business and expand their reach.
Business owners can use debt financing to purchase the latest technologically advanced equipment to enhance efficiency and costs. They can use it to invest in more inventory and new customer acquisition. Such funds can also be used to expand the production capacity or open up a presence in new geographies or locations. Taking out a loan provides room for the business to grow without risking the company profits. Debt financing provides flexible funding solutions without requiring significant collateral or diluting ownership of the company. Reach out to experts at Tata Capital to know more about how you can use debt optimally to take your business to newer heights.
15 December 2021
4 mins read
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