DEBT FINANCING

Definition: A method of financing in which a company receives a loan and gives its
promise to repay the loan.
Debt financing includes both secured and unsecured loans. Security involves a
form of collateral as an assurance the loan will be repaid. If the debtor defaults on
the loan, that collateral is forfeited to satisfy payment of the debt. Most lenders
will ask for some sort of security on a loan.
The financing manager must consider whether the debt will contribute to or detract
from the firms operations. He also investigates ways to improve profitability, and
analyze markets for business opportunities, such as expansion, mergers or
acquisitions.
ADVANTAGES AND DISADVANTAGES OF DEBT FINANCING
Advantages to debt financing:
Retain control. When you agree to debt financing from a lending institution, the lender
has no say in how you manage your company. You make all the decisions. The
business relationship ends once you have repaid the loan in full.
Tax advantage. The amount you pay in interest is tax deductible, effectively reducing
your net obligation.
Easier planning. You know well in advance exactly how much principal and interest you
will pay back each month. This makes it easier to budget and make financial plans.
In an inflationary economy, debt may be paid back with cheaper pesos.

Disadvantages to debt financing:

High rates: Even after calculating the discounted interest rate from your tax
deductions, you might still be faced with a high-interest rate because these will vary with
macroeconomic conditions, your history with the banks, your business credit rating and
your personal credit history.

Repayment: A debt requires repayment irrespective of whether the debtor makes a profit
or loss with the loan.

Restrictions: Just as equity financing restricts the decision-making powers of an

entrepreneur, debt financing also impose restrictions such as not allowing for alternative
financing options when the debt remains in place.

Money must be paid back within a fixed amount of time.

TERM LOAN
is a monetary loan that is repaid in regular payments over a set period of
time.
may be obtained from Private commercial banks, insurance institutions,
government controlled banks and agencies such as GSIS, DBP and so on.
most term loans have a maturity of one to five years with a few existing
between five to fifteen years in maturity.

TYPES OF TERM LOAN

Short-term loans. which have a maturity of one year or less. Its
purpose is to cover cash shortages resulting from a one-time increase
in current assets, such as a special inventory purchase, an unexpected
increase in accounts receivable, or a need for interim financing.

Intermediate-term loans. term loans finance the purchase of furniture,

fixtures, vehicles, and plant and office equipment. Maturity generally
runs more than one year but less than five. Consumer loans for autos,
boats, and home repairs and remodeling are also of intermediate term.

Long-term loans. which includes all forms of financing with final

maturities longer than 10 years. Used to purchase real estate and are
secured by the asset itself.

COMMON CHARACTERISTICS OF LOANS

Time to maturity. Time to maturity describes the length of the loan contract.
Loans are classified according to their maturity into short-term debt,
intermediate-term debt, and long-term debt.

Repayment Schedule. Payments may be required at the end of the contract

or at set intervals, usually on a monthly or semi-annual basis.

Security. Assets pledged as security against loan loss are known as

collateral. Credit backed by collateral is secured. In many cases, the asset
purchased by the loan often serves as the only collateral. In other cases the
borrower puts other assets, including cash, aside as collateral. Real estate or
land collateralize mortgages. Unsecured debt relies on the earning power of
the borrower.
 TERM LOAN AGREEMENT RESTRICTIONS

Maintaining a minimum amount of working capital, or net working

capital or minimum current ratio.
Obtaining lenders prior approval before the debtor can issue
additional debt.
Providing the lender with periodic financial statements on a regular
basis.
Obtaining lenders approval of major personnel changes.

Marginal borrowers are more likely to find more restrictive covenants

(certain restrictions on the assets of the borrower) than a more creditworthy
borrower.

ADVANTAGES OF TERM LOANS

Cheap. it is a cheaper source of medium-term financing.

Tax Benefit. interest payable on term loan is a tax deductible expenditure
and thus taxation benefit is available on interest.
Flexible. term loans are negotiable loans between the borrowers and lenders.
So terms and conditions of such type of loans are not rigid and this provides
some sort of flexibility.

DISADVANTAGES OF TERM LOANS

Obligation. Yearly interest payment and repayment of principal is obligatory
on the part of borrower. Failure to meet these payments raises a question on
the liquidity position of the borrower and its existence will be at stake.
Control. The bank as lender may impose some very restrictive arrangement
in the loan agreement relative to company operation.