Debt finance results to benefits such as tax shield and the diminution of free cash flow problems by enhancing managerial behavior while the expenses of debt financing include agency expenses and bankruptcy cost which results from the conflicts between shareholders and debt holders (Fama & French, 2002).
The consequences of debt are significant and often overlooked, from high interest rates and fees to limiting your ability to invest in your future. It can prevent you from saving for retirement, buying a home, or pursuing your dreams.
Drawbacks of debt financing
Having high interest rates – Interest rates vary based on various factors including your credit history and the type of loan you're trying to obtain.
Borrowing too much money can result in excessive debt, which can make it harder to manage your finances and pay your monthly bills. It may also hurt your credit rating and your reputation as a borrower.
Is Debt Financing or Equity Financing Riskier? It depends. Debt financing can be riskier if you are not profitable, as there will be loan pressure from your lenders. However, equity financing can be risky if your investors expect you to turn a healthy profit, which they often do.
Japan is the largest foreign holder of public U.S. government debt, owning $1.13 trillion in debt as of August 2024.
Rising debt reduces business investment and slows economic growth. It also increases expectations of higher rates of inflation and erosion of confidence in the U.S. dollar. The federal government should not allow budget imbalances to harm the economy and families across the country.
Stopping payment on a debt means you could face late fees and accruing interest. Additionally, just because a creditor agrees to lower the amount you owe doesn't mean you're free and clear on that particular debt. Forgiven debt could be considered taxable income on your federal taxes.
During periods of financial instability, banks may increase their interest rates on loans, potentially impacting your ability to make regular payments. Some loans may also use your credit score to determine the interest rate.
Debt Financing Over the Short-Term
A common type of short-term financing is a line of credit, which is secured with collateral. It is typically used with businesses struggling to keep a positive cash flow (expenses are higher than current revenues), such as start-ups.
Generally, debt is cheaper than equity because the interest paid on it is often tax-deductible and lenders usually expect lower returns than investors. IRS. "Topic no. 505, Interest Expense."
Wealthy family borrows against its assets' growing value and uses the newly available cash to live off or invest in other assets, like rental properties. The family does NOT owe taxes on its asset-leveraged loans because the government doesn't tax borrowed money.
Experiencing bad debt could put you in a position where you, in turn, are unable to honour your financial commitments, thus spreading financial harm further down your business ecosystem.
You may lose your customer if the agency has poor communication skills. If the agency takes a heavy-handed approach, your reputation may be damaged. Your business may not be a priority - you may be one of many businesses the agency works on behalf of. The agency may not use legally trained employees.
Our growing debt also has a negative impact on the incomes and economic opportunities available to every American. When high levels of debt crowd out private investments, businesses utilize fewer assets, which translates into lower productivity and, therefore, lower wages.
China is one of the United States's largest creditors, owning about $859.4 billion in U.S. debt. It doesn't own the most U.S. debt of any foreign country, however. Nations borrowing from each other may be as old as the concept of money.
Now, the resulting overhang of federal debt could itself be the cause of a future crisis. Our gross national debt exceeds $35 trillion. This puts the federal debt held by the public at a staggering 99% of U.S. gross domestic product, nearly as high as its peak at the end of World War II.
Who owns the most U.S. debt? Around 70 percent of U.S. debt is held by domestic financial actors and institutions in the United States. U.S. Treasuries represent a convenient, liquid, low-risk store of value.
If China (or any other nation that has a trade surplus with the U.S.) stops buying U.S. Treasuries or even starts dumping its U.S. forex reserves, its trade surplus would become a trade deficit—something which no export-oriented economy would want, as they would be worse off as a result.
Japan and China have been the largest foreign holders of US debt for the last two decades. From 2000 to 2023, annual totals are based on data from December, while the 2024 data is updated through April. Inflation adjusted to the 2023 calendar year.
By buying a U.S. savings bond, you are lending the government money. When you redeem a bond, the government pays you back the amount you bought the bond for plus interest.
Debt financing can be difficult to obtain. However, for many companies, it provides funding at lower rates than equity financing, particularly in periods of historically low-interest rates. Another advantage to debt financing is that the interest on the debt is tax-deductible.
Mezzanine financing is a business loan that offers repayment terms adapted to a company's cash flows. It is a hybrid of debt and equity financing—similar to debt financing in that you need cash flow to repay the loan, but with repayment terms that are more flexible than conventional debt financing.