Questions to ask before taking on debt financing

If you are a business owner who is looking for additional working capital, you may be considering taking on debt financing. However, before you immediately apply, for a business loan, it is important to carefully consider all of your options. If your business is short of cash, or even if you are in a crisis situation, you should not let that make your decision about what type of financing to take on. Savvy business owners take the time to plan and learn all they can, about their financing options. Here are some questions to ask before taking on debt financing:


  • What do you need the debt financing for? You need to have a clear idea of how you are going to spend the money. You should identify if the funds are going to be involved in a fixed or variable cost. It is important to keep in mind that if the money is going to be used for a fixed cost (like new equipment), then the return on your investment, will not be realized, for quite a while. If the money will be involved in a variable cost (such as raw materials or even marketing) then you should be able to realize a return on investment much sooner.
  • How much accounts receivable do I have and how current are they? The amount of accounts receivables that you have, as well as how current they are, will give you an idea of how much cash inflow; you will have to repay debt. You should be intimately acquainted with the paying habits of your customers. You may want to even consider giving them an incentive, for paying their bills earlier. Finally, you should make sure that your payment terms, are similar with your competitors in your market.
  • How old is my business? This is such an important question, because debt financing can literally be dangerous, for a very new business. New businesses most often have trouble making their payments, due to low cash flow. This means that you could be hurting your future, if you have assumed too much debt financing. Keep in mind that even though debt financing provides tax advantages, those could be minimal in the early stages of the business. As your business grows and develops, it will be much able to take on debt financing. In addition, because your cash flow will be more predictable, your risk of bankruptcy will decrease and your tax advantages will be greater.


If you decide that debt financing is not right for you and your business, then there are some alternatives to consider. A couple of these alternatives are-


  • Equity financing-This type of financing is done by selling shares in your business, to investors. There are various types of investments that can be made in your business. You need to keep in mind that if your business fails, you will not have to repay the investment. However, you need to be prepared to give up some control of your business, since investors will be looking for some control of their investments.
  • Hybrid financing-This has when a business chooses to use a combination of both debt and equity financing. However, many business owners are left wondering how much of each to do. This can be determined by dividing your total debt amount by your total equity amount. It is important to understand that potential lenders and investors, will want to see this number, to get an idea of how financially viable your business is. This is also an important indication for investors because if your business goes under, debt holders will get priority, for repayment over equity-holders in recovering funds.