Classification and uses of debt or loans
- Debt capital in business administration
- Liquidity and debt
- Advantages of debt
- Disadvantages of debt
If you want to finance something, capital is usually used. This is roughly explained by debt and equity. The equity describes the already existing money, which comes from own resources and nobody has to be repaid. If equity is insufficient for financing, debt capital comes into play. Borrowing thus describes the part of the capital that comes from other investors. These are also called creditors, whereby the borrower automatically assumes the role of the debtor. The resulting debts are often referred to as liabilities or provisions, but mainly in the area of corporate financing. In a company one speaks in combination of equity and debt of the total capital.
All contingent liabilities represent the provisions. This means that certain liabilities are expected or assumed, but their amount and amount have not yet been determined. For example, a company always has to set up tax provisions because it has to pay trade and sales tax at the end of a fiscal year. Also, provisions for losses in the event of a loss or liabilities from the company pension scheme are included in the provisions.
Liabilities are a financial obligation to a creditor, such as suppliers. Also loans, which a company receives from a bank, count under the concept of liabilities. In addition, down payments received also count as a liability if a customer has already paid a certain amount before receiving his goods. Liabilities occur in every business because unpaid invoices count as a liability for the period of non-payment.
Debt capital in business administration
In many cases, companies do not finance themselves, but always with a certain amount of debt. Of course, the motto is: The less debt in a company, the more independent and secure the company is there. If a company can predominantly finance itself from its own capital reserves, this is considered to be very stable.
Liquidity and debt
Of course, the liquidity of a company has something to do with debt. If a company can settle short-term debts directly from so-called currently available cash, one speaks of a first-degree liquidity. For example, the company is then able to pay off loans and advances, bills or all liabilities directly from its own resources. If this is the case, one speaks of a solvency, ie ability to pay. The opposite of solvency is the insolvency, which describes the insolvency of a company.
Advantages of debt
Companies seldom finance 100% of their own resources, even if they could do so. The reason for this is that own capital is more expensive than debt capital. This is due to the fact that the interest generated by the debt can be deducted from the tax. On the other hand, investments out of pocket can not be made tax-deductible. Borrowing is also used for the purpose of keeping “taxes in check”.
Of course, equity does not always have to come from one person or from the founder of the company itself. Another shareholder can join the company and raise equity. Although this is a common form of equity financing, the foreign shareholder usually has to be given codetermination rights. Borrowed capital, on the other hand, does not require any participation rights, which may be an advantage for the company. So if you want to keep the complete control in your company, you use leverage.
Disadvantages of debt
Borrowing always carries the risk of insolvency. The more debt capital in a company, the greater the risk. After all, foreign capital is always an obligation and a debt. It is therefore important that the company knows its obligations precisely and tries to bring the debt and equity in a balanced relationship. In addition, banks tend to lend to companies with a high equity ratio rather than to companies with already high leverage.