Meaning of Debt Financing Part I

Debt Financing 1

Whether for founding yourself or purchasing new machines – external financing is a good way to enable you to achieve your professional goals. It depends largely on the content of the contract and the repayment modalities .

What is debt financing?

According to USVSUKENGLISH, a debt financing is the provision of financial resources for your company. The money from external sources flows into your company. This means that the creditor is an outside person or company . Usually a fixed interest rate is agreed for the entire period of repayments in order to ensure the creditor a corresponding income. The interest rate added to the repayment installment gives the amount of your monthly repayment.

External financing can take the form of internal and external financing . Internal financing is used when it comes to provisions , for example . In the case of external financing, the financial resources are outside the company.

The most common type of debt financing is the bank loan. Alternatively, a private loan can be arranged with someone you know.

Which forms can be distinguished?

If you need outside capital for your corporate financing , various forms are available. With regard to their duration, these can be divided into short-term, medium-term and long-term financing:

The short-term debt financing

The short-term debt financing is only available for a few weeks or months . They are agreed for small sums or in the event that you are waiting for your customers to settle a claim.

Bank loans

Short-term bank loans can be overdrafts, bills of exchange or Lombard loans . They have in common that they all have a very high interest rate and are therefore only suitable for corporate financing in exceptional cases.

Loan loans

In the case of a loan, the bank will provide you with their credit rating so that you can make small purchases . Typical examples of this are the acceptance credit / bill of exchange credit and the guarantee credit. Loan borrowing can, in the broadest sense , be compared to a guarantee .

Trade credits

Trade credits are taken directly from your customers or suppliers . In the event of a financial bottleneck, your suppliers can grant you an appropriate delay to settle your outstanding liabilities. A customer loan is used when you request a down payment or partial payment for your services .

Medium and long-term debt financing

Both the medium and long-term types of debt financing are characterized by a repayment period of several months to several years . Most of these are professional creditors.

Bank loans

Bank loans are long-term types of financing if they have a term of at least four years . The rate is usually fixed so that you can plan your monthly liabilities well.

Foreign trade credits

Foreign trade credits include both the return credit and the negotiation credit. They are awarded in the import-export sector.

Debentures and bonds

By issuing securities, the creditor is secured against the debtor. Typical debentures and bonds are industrial bonds, bonds with warrants, zero-coupon bonds or convertible bonds.

Promissory note loan

Promissory note loans are only granted to large corporations that have the appropriate creditworthiness . The loan amount is in the high-priced sector and is secured by a non-marketable promissory note.

Let’s say you own an office furniture company. After a machine shows recurring defects, you decide to replace it. The gross investment amounts to 900,000 euros.
Unfortunately, your internal financial resources are currently insufficient to cover the full acquisition costs of the machine. You decide to finance part of the debt and therefore want to calculate the required debt:

Post amount
acquisition cost € 900,000
In-house funds – € 150,000
Amount to be financed: € 750,000
Loan fees + short-term commitment interest € 3,300
Total interest payments € 65,000
Total cost of debt financing € 818,300

You can see from this example that external financing is always associated with a significant increase in costs . This is related to the interest payments to the creditor.

The special forms of external financing

Instead of a normal loan, in some cases you can also choose a special form of financing . This is particularly often granted in connection with direct business operations. The creditor is usually a different company.

Asset backed securities

These are securities that are backed by rights or payment entitlements. Typical examples of this are Pfandbriefe.


The lease is particularly common in connection with the procurement of machines and vehicles used. The manufacturer of the machines or vehicles will make them available to you. In return, you pay him the monthly leasing installments. With leasing, you are not the owner of the goods, but the manufacturer as before. After the leasing period, you can take over the vehicles or machines for a final price.


With factoring, you sell your outstanding accounts receivable to special factoring companies. The selling price is on average three to five percent below the value of the invoices sold.

Features of outside financing

In order to be able to differentiate between equity and debt financing, some characteristics of the procurement of outside capital must be defined. The most important aspect is of course that the borrowed money flows into your company from external sources. So it must not come from in-house assets .

  • The majority of creditors demand a certain amount of security. These can be tangible or intangible assets . In all cases, however, you must be able to show proof of your liquidity in the form of the company’s annual balance sheet . A professional business plan is required for startups .
  • The investor is the creditor. He assumes no liability for any irregularities within the company. Furthermore, he has no rights of participation in your company.
  • The external financing exists over a certain period of time. The end must be fixed by a date . With some types of financing, you can pay off your debts earlier.
  • There is a repayment obligation, also known as the nominal amount . As the debtor, you have to repay the borrowed amount in full plus the agreed interest to the creditor.

This differentiation is of particular importance in the event of insolvency, because lenders have top priority during the insolvency proceedings.

Debt Financing 1