Debt Financing

What is debt financing?

Debt Financing is the financing or facilitating of an investment using external debt. For instance, when one borrows externally such as accessing bank loan or mortgage.

Debt financing is required when other sources of financing are costly.

Debt financing is necessary to take advantage of low cost of borrowing and tax benefit advantages.

Example

Clean Dollar ltd is a dry cleaner service provider in Minnesota. The company management has decided to re-engineer the business by acquiring new machinery. Unfortunately, it has some financial constraints and it has opted to access a long-term debt to finance its acquisition. If the organization accessed a loan of $50,000. Show how this was used to finance the acquisition of the fixed asset

Solution

To answer this question, the Accounting equation A=C+L is paramount. A balance sheet will also portray the concept of financing as demonstrated below;

A=C + L

Since owner’s equity is zero, it means the borrowed capital of $50,000 was utilized as follows

A=L, such that

50,000 (L) = 50,000 (A)