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debt financing

Also called: debt funding, loan financing

Raising money through loans or credit lines that must be repaid with interest on a schedule, whatever the results.

Debt financing raises money through loans or credit lines that must be repaid with interest on a fixed schedule, whatever the results. Nobody new owns any part of the company, and once the loan is repaid the relationship ends. Lenders are paid first, so debt is usually cheaper than investors' money.

The cost is certainty in both directions. Interest is a new fixed cost: it raises the break-even point of every month and is paid in cash, including in the weakest season. The principal must come back on a date, so the plan has to generate or raise that cash in time. Banks often add conditions, such as a minimum cash balance or limits on further borrowing.

Debt fits predictable cash flows: a business with steady contribution can carry interest comfortably and keep its shares. For an uncertain plan, test the weak case with the loan in it: interest deepens the cash hole and the repayment comes on top. A useful check is interest coverage, operating profit ÷ interest, which should stay well above 1 even in the weak case.

Example

A bank offers Klasna 6,000,000 UAH at 20% a year, interest only, the full amount back in three years. Interest: 6,000,000 × 20% = 1,200,000 a year, or 100,000 a month.

At last year's contribution of 173.44 UAH per lesson, 100,000 a month is 100,000 ÷ 173.44 ≈ 577 more lessons every month just to break even.

In the EU plan's weak case the deepest cash need is 4,500,000 without the loan's costs. With the loan's interest of 300,000 a quarter it grows to 5,950,000, and after two years the project is still 5,250,000 down, with the 6,000,000 principal still to repay. Coverage in a weak year: 800,000 ÷ 1,200,000 = 0.67.

Common mistakes

  • Comparing only the interest rate. Debt is cheap money only if the business can pay it in its weakest months.
  • Forgetting the principal. Interest-only loans still end with the full amount due.
  • Testing it only in the base case. Run the weak case with interest included; the cash hole gets deeper.
  • Ignoring covenants. A minimum cash balance or borrowing limits can bind when cash is tight.
  • Treating interest as a one-off. It is a fixed cost that raises break-even every month the loan runs.

Learn it in the course