Let us have a look at advantages and disadvantages of Financing with Debt:
- Utilization of Resources — When a business use debt to finance its operation, they got no option than to fully utilize their resources because they will have to pay back the debt and interest to their creditor.
- Short-Term Needs — Debt finance can easily be secured on short-term bases. This makes it very advantageous to the small business as finance of this type can easily be secured for short-term business needs.
- Tax Advantage — Debt financing also offers a tax advantage to business as interest is deductible for income tax purposes.
- No Future Lender Claims — Lenders has no direct claim on future earnings
- Not Dilutive — Debt does not dilute the ownership of your small business.
- Simple Loan Repayment — Lenders are only entitled to loan ‘repayment and interest on a loan.
- Future Impact Forecasting — Interest and principal repayment are based on fixed percentage and can be forecast.
The main disadvantage of this type of financing is that it requires a small business to make regular monthly payments of principal and interest. Because of a shortage of cash flow experience by young business, it is usually difficult to make a regular payment to creditors.
Most lenders provide severe penalties for late or missed payments, which may include charging late fees, taking possession of the collateral, or calling the loan due early.
Failure to make payments on a loan, even temporarily, can adversely affect a small business’s credit rating and its ability to obtain future financing.
Another disadvantage associated with debt financing is that its availability is often limited to established businesses. Since lenders primarily seek security for their funds, it can be difficult for unproven businesses to obtain loans.
The amount of money small businesses may be able to obtain via debt is likely to be limited, so they may need to use other sources of financing as well