Question

What are benefits and risks of debt financing?

Answer 1

Long term Debt Financing.

Advantages:

1. Debt is the least expensive source of long-term financing.

2. It gives you flexibility in your capital structure.

Disadvantages:

1. Debt usually has a fixed maturity date. Thus a provision for repayment of debt must be made.

2. There is a permanent burden to the company on Interest payments.

Short term Debt Financing.

Advantages

1. The interest on the debt provides the company with the benefit of tax saving.

2. There is no interference in business operations by the creditors because they are not entitled to vote.

Disadvantages:

1. Risk management in an improper way for Short Term debt can lead to a drain in Liquidity of the firm.

2. The interest and principal at a specified time by the company. Interest and principal's non-payment on time can lead company into insolvency.

3. May contain restrictive agreements which may restrict the company's operating flexibility in the future.