Ravi, a shop owner in Mumbai, borrowed ₹50,000 from a bank to expand his mobile accessories business. He repaid the loan with interest, keeping full control of his shop. This is debt financing—taking a loan to grow without giving up ownership. In 2023, Indian small businesses raised over ₹3 lakh crore this way.
What is debt financing?
Debt financing means borrowing money and repaying it later with interest. Businesses can borrow through:
- Bank Loans: Fixed loans for specific purposes, like buying equipment or inventory.
- Bonds: A way for larger businesses to borrow from investors.
- Lines of Credit: Flexible borrowing where you take only what you need.
- Debt Consolidation Loans: loans that combine multiple debts into one, often with a lower interest rate.
This type of financing helps businesses grow without giving away ownership, unlike equity financing, where investors buy shares of the company.
Advantages of debt financing
1. Keep full ownership
Debt financing allows business owners to raise funds without giving up control over their business decisions or profits.
For example, Ravi borrowed ₹50,000 to expand his shop but retained full ownership and kept all the profits he earned.
2. Save on Taxes
Loan interest is tax-deductible, meaning it reduces the taxable income.
For example, if Ravi paid ₹2,000 as loan interest in a year, he could lower his taxable income by ₹2,000, saving money for his business.
3. Predictable Repayments
Debt financing comes with fixed repayment schedules.
For instance, Ravi knew he had to pay ₹2,000 per month. This predictability made it easier for him to plan his shop’s budget.
4. Cheaper Than Equity Financing
Debt is often cheaper than giving away shares.
If Ravi had sold 20% of his shop to an investor, he’d lose 20% of future profits forever. Instead, he chose a loan with a fixed cost.
5. Build a Strong Credit History
Timely loan repayments help improve a business’s credit score, making it easier to get future loans at better rates.
For example, because Ravi paid his ₹2,000 monthly payments on time, his credit score improved, allowing him to borrow more at lower rates.
Disadvantages of debt financing
1. Risk of non-payment
Debt financing carries the risk of non-payment, which can result in penalties or financial trouble.
For example, if Ravi’s shop had a bad month and missed a loan payment, he could face penalties or even bankruptcy.
2. Fixed Monthly Payments
Repayments are mandatory, even during tough times, which can affect cash flow.
For example, if Ravi’s sales drop in a slow month, he might struggle to pay his loan while managing shop expenses.
3. Too Much Debt is Dangerous
Borrowing from multiple lenders can lead to unmanageable debt. High debt-to-equity ratios make business riskier for investors.
For example, if Ravi took loans from several banks, his total debt might exceed his ability to repay.
4. Pressure on Revenue
Regular interest payments can reduce profits, leaving less money for other business needs.
For example, Ravi paying ₹2,000 monthly interest on his loan meant he had less money for inventory or marketing.
5. Restrictions from Lenders
Lenders may impose restrictions on how borrowed money is spent.
For example, Ravi’s bank loan might only allow him to use the money for his shop’s expansion, not for personal expenses or luxuries.
How Debt Consolidation Can Help
Debt consolidation is a strategy to manage multiple debts. For instance, if Ravi had loans from three different lenders with varying interest rates, he could combine them into one debt consolidation loan. This has several benefits:
- Lower Interest Rates: Reduces the overall interest paid.
- Simpler Payments: One payment instead of many.
- Better Cash Flow: Lower monthly payments give Ravi more breathing room.
Example Table: Ravi’s Debt Before and After Consolidation
| Loan Type | Amount (₹) | Interest Rate (%) | Monthly Payment (₹) |
| Bank Loan | 30,000 | 12% | 3,200 |
| Credit Card Debt | 15,000 | 18% | 2,700 |
| Personal Loan | 20,000 | 14% | 2,400 |
| Consolidated Loan | 65,000 | 10% | 5,500 |
By consolidating his debts, Ravi saves over ₹2,800 each month!
Conclusion
Debt financing helps businesses grow without losing control, but it can be challenging with regular payments and the risk of borrowing too much.
For example, Ravi used debt financing to expand his shop but faced the pressure of monthly payments. He then used debt consolidation to lower interest rates and simplify payments. According to the Indian Banking Association, 70% of small businesses benefit from debt consolidation in improving cash flow. When used wisely, debt financing can help businesses succeed while staying financially stable.
