Debt is to lend money from a third party upon a mutually agreed interest rate in addition to the principal amount, when returned back.New companies usually use this to operate their business.In fact, the strongest corporate balance sheets have some level of debt. Debt can be defined as borrowed money which a company utilizes  in operation of its business.The classical source for debt is bank but it can be borrowed from any source like another private company, a friend or a family member.

Advantages of Debt Financing

Maintain ownership: When you borrow from third party, you promise the lender that your payments will be in time. Now you are free to take decision about the borrowed money and your own business without any one else giving directions into day to day affairs of your business.

Tax Deduction: Tax benefits are one of the most attractive things about debit financing. Because the principle loan and interest paid upon that loan are usually termed as business expense, these are subtracted from calculation of your business taxes.This is a huge benefit for your business, whatever the tax rate is.

Low Interest Rate: You can see the  effect of tax deductions on bank interest rate.For example, if the bank charge you at 10 % against your loan and the government taxes you at 30 %, then there is a benefit against using loans. in this scenario,  it is :10%  times(1-30%), which equals 7%. It means you are paying at the rate of 7% after tax deductions.

Demerits of Debt Financing

Repayments: The major demerit of debt financing is to return borrowed money, even if your business fails.When you face bankruptcy, your lenders demand for repayments before any of your equity investors.

High Interest Rates:  Although, interest rate is deducted from your tax deductions, you even face high interest rates. As interest rates changes with macroeconomic conditions.

Effect on credit rating:  Your business credit rating can be viewed by your bank history and your personal credit history.It looks good to borrow  money for your business, but higher you borrow, higher is the risk to the lender and ultimately more interest rate you have to pay.

Cash and Collateral: As you use the loan to invest in your business, you have to make sure the regular and sufficient cash flows in time for repayments.Ultimately, you may face collateral against the loan if you default on your repayments.

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