Business Financing: Debt, Equity, Short-Term, and Long-Term

Practice flashcards covering sources of business financing, debt vs equity financing, advantages and disadvantages, and short-term vs long-term financial instruments.

What is debt financing?

Debt financing refers to taking out a conventional loan through a traditional lender like a bank.

How does debt financing work, and what term is often used to describe it?

Debt financing occurs when a company raises money by selling debt instruments (most commonly bank loans or bonds), incurring interest costs and promising to repay the loan; it is often referred to as financial leverage.

What are the eight examples of debt financing listed in the text?

Traditional bank loans, government-backed loans, lines of credit, credit cards, equipment loans, real estate loans, peer-to-peer loans, and personal loans.

What is equity financing?

Equity financing involves securing capital in exchange for a percentage of ownership in the business by selling shares to existing shareholders or new investors.

How does equity financing work?

Equity financing works by selling a company's stock in exchange for cash. The proportion sold depends on how much is invested and the business's value at the time; as the business grows, so does the value of the investor's stake.

What are the four sources of equity financing?

Business angels (BAs), venture capital, crowdfunding, and the stock markets.

What are Business angels (BAs)?

Wealthy individuals who invest in high-growth businesses in return for a share in the business.

What are the four listed advantages of equity financing?

1) Less risky than debt, 2) No future obligations, 3) Gain investor network, and 4) No fixed timeline.

What are the three listed disadvantages of equity financing?

1) Shared decision making, 2) Potentially more expensive, and 3) Investor pressure.

What are the four listed advantages of debt financing?

1) Retain ownership, 2) Interest is tax deductible, 3) No future obligations, and 4) Variety of terms/rates.

What are the three listed disadvantages of debt financing?

1) Must repay in future, 2) Usually requires collateral, and 3) Impacts cash flow.

Why might debt financing offer greater long-term financial benefits than equity financing?

With equity financing, investors are entitled to profits and a portion of the proceeds if the company is sold, which reduces the amount of money earned from owning the company outright.

What is short-term financing?

Taking out a loan to make a purchase, usually with a loan term of less than $1\,year$.

What are the three most common types of short-term financing mentioned?

Buy Now Pay Later, Unsecured Personal Loans, and Payday Loans.

What business situations call for the use of short-term financing?

Urgent need for quick cash, difficulty in cash flow management, operating as a young business for less than $1\,year$, needing to purchase equipment or inventory, cash shortages during holiday seasons, taking on more clients, and planning for business expansion.

What is trade credit, and what standard repayment window is provided?

A business-to-business (B2B) agreement in which a customer can purchase goods without paying cash up front and pay the supplier at a later scheduled date; businesses usually give buyers $30$, $60$, or $90\,days$ to pay.

What are commercial bank loans?

Commercial credit issued by banks to companies to access funds as needed for daily operations, new business opportunities, equipment purchases, or unexpected expenses.

What is commercial paper?

An unsecured, short-term debt instrument issued by corporations at a discount from face value to finance short-term liabilities such as payroll, accounts payable, and inventories.

What is a promissory note, and how does its typical issuance differ from commercial paper?

A written promise to pay a certain sum of money to a specified person or entity on a specific date or on demand; commercial paper is usually issued by businesses to other businesses, whereas promissory notes are usually issued by businesses to individuals.

What is a secured loan?

Money borrowed secured against an asset you own (such as a mortgage or car financing); it typically has lower interest rates than unsecured loans but is a much riskier option.

How is long-term finance defined?

Any financial instrument with a maturity exceeding $1\,year$ (such as bank loans, bonds, leasing, other debt finance, and public or private equity instruments).

According to the summary table, how do short-term and long-term funding compare across repayment duration, purpose, payment schedule, and application process?

Short-term funding has a repayment duration listed as $>1\,year$, is used for working capital, has a daily/weekly payment schedule, and a less complex application process. Long-term funding has a repayment duration of $5$ to $15\,years$, is used for big-sized projects and purchases, has a monthly payment schedule, and a more involved and extensive application process.