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Debt Financing UPSC NOTE

 


  • Debt financing refers to the process of raising funds for a business or government entity through the issuance of debt securities

  • such as bonds or loans, which are to be repaid over a specified period with interest.


Types of Debt Financing:

  • a. Bonds: Bonds are debt securities issued by governments, corporations, or other organizations to raise capital. 

  • They have a fixed maturity date and pay interest to the bondholders.



  • b. Loans: Loans involve borrowing money from financial institutions or individuals, usually with an agreed-upon interest rate and repayment schedule.

  • c. Lines of Credit: Lines of credit provide businesses with access to a pre-approved borrowing limit that they can draw upon as needed.



Advantages of Debt Financing:

  • a. Retain Ownership: Unlike equity financing, debt financing allows the business owner to retain ownership and control of the company.

  • b. Tax Benefits: Interest payments on debt can be tax-deductible, reducing the overall tax liability of the business.

  • c. Fixed Repayment Terms: Debt financing typically comes with a predetermined repayment schedule, making it easier for businesses to plan their cash flow and manage financial obligations.


Disadvantages of Debt Financing:

  • a. Interest Payments: Borrowers must make regular interest payments on the debt, increasing the cost of capital.

  • b. Risk of Default: If a business fails to meet its debt obligations, it may face legal consequences, loss of assets, or damage to its credit rating.

  • c. Limited Flexibility: Debt financing creates an obligation to repay the principal and interest according to the agreed-upon terms, which may limit a company's financial flexibility.

  • Both debt financing and equity financing are considered as part of capital receipts for the company, as capital receipts are receipts that create liabilities or reduce financial assets

  • Funds from these would be used by company for capital expenditure such as to grow or expand its operations.

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