Debt financing refers to an organization that borrows money. Usually borrowing it from an outside source: Principles of Finance Course Work, UOM, Malaysia
|University of Malaya (UOM)
|Principles of Finance
Debt financing refers to an organization that borrows money. Usually borrowing it from an outside source to finance their organization’s expenditure and promise that they will return the principal borrowed plus the interest charged for borrowing the money. For debt financing, the lender of the money is usually the financial institutions such as banks.
One of the advantages of debt financing is that it allows for more money to be borrowed without giving away shares of the firm, making it ideal for company owners that prefer to make their own decision about the organization’s future. But the organization should not have too much debt because taking on too much debt can negatively impact the credit rating of the organization and the ability to get more external funding.
Types of debt financing that can be used by Pensonic to fund its operations are Lines of Credit and Secured Loans. First, a Line of Credit is a financial arrangement in which the lender of money allows the borrower to borrow money up to the maximum amount that is allowed by the lender. For example, Bank A allows Firm B to borrow money up to a limit of RM10,000,000 to fund its business operations.
The good thing about Line of Credit is that the borrower only needs to pay the interest of the amount used within the limits, which means that if Firm B only uses RM5,000,000 out of RM10,000,000, then Firm B only needs to pay the interest of RM5,000,000 plus principal. Line of Credit is a useful financial tool for taking care of any short-term expenditure such as paying wages, paying off debt to suppliers that are due, or even another short-term usage.
For Pensonic, when there is an unexpected expenditure that must be paid off or when there is a good opportunity for investment in the market, a Line of Credit may help Pensonic to cover the amount that they are lacking. But for Pensonic to obtain a Line of Credit, they will need to present a good report of financial statement and any other financial documentation to the lender of money to ensure the ability of Pensonic to pay off the loan and interest. The interest rate and amount borrowed will vary depending on the credit rating of Pensonic.
Another type of debt financing that Pensonic can apply for their business operations funding is a Secured Loan. A secured Loan is a type of debt financing in which the borrower of the money pledges or allows the lender to secure part of the borrower’s asset in return for lending the loan. This is to ensure that the borrower will not run away from the debt and that the lender will be protected.
In the case of the borrower not being able to pay back the loan, the lender may sell the pledged asset to any buyer who is willing to buy the asset at the price of the principal borrowed plus the interest. Interest for Secured Loan tends to be lower compared to other types of debt financing because the lender is guaranteed their money back, therefore has a lower risk of losses. So for Pensonic, if they are looking for a low-interest loan that they are able to pay back on time, Secured Loan would be a good choice of debt financing.
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