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Use debt capital for successful financing

Borrowed capital is capital that is granted to legal entities (ie companies, corporations or even government entities, such as countries and municipalities) for a limited period by their creditors and provided with the obligation to repay or in the form of provisions or deferred income be funded from the inside. Read ibgplay.org for a critique

Among other things, this article provides answers to these questions:

  • What is long-term debt?
  • What is short-term debt?
  • What is borrowed capital in the balance sheet?
  • Are provisions always debt?

The time limit, terminability and obligation to repay differentiates the debt from equity. Unlike equity, the repayment claim of the creditors is independent of success. For example, dividends on equity interests only have to be paid out in the event of the company’s success, while debt capital loans are due irrespective of the economic success of the company.

This also applies if shareholders grant the company a shareholder loan, ie they provide debt financing and do not provide equity capital. There are no voting rights or liability regulations associated with borrowed capital.

Households and debt

Households and debt

For households, the notion of debt capital as well as of equity plays a major role in real estate financing. While equity comprises all funds contributed by the buyer (financial assets, own contributions and so on) and has a significant impact on the loan commitment and also on the interest rate, the debt capital covers all funds granted by third parties. This includes the loan from the bank for home purchase as well as public service or personal loans. The lenders generally have their benefits secured by real estate liens.

borrowing forms

borrowing forms

Apart from the leverage arising from so-called internal financing, such as provisions and deferred income, borrowed capital is usually provided from outside. This usually happens in the form of bank loans as well as customer or supplier loans. These fall, together with other financial titles such as bonds, all under the generic term of the liabilities.

Provisions are formed for payments to which the legal entity is bound by future obligations, such as tax payments or pension payments. Changes in debt are referred to as the “balance of payments”, and public budgets are called “budget balances”.

Debt capital in the company

Debt capital in the company

For both analysts and creditors of a company, the distinction between equity and debt plays a major role. The simplest indication of classification is the repayment factor – once the repayment option is available, the funds must be accounted for as debt. For example, this also applies to reserves that are due only with a fifty percent probability.

Once the return on capital is independent of the economic success of the company, it can also be assumed that it is debt capital. There are also some mixed forms, also called “mezzanine equity”. These include, for example, subordinated loans or other forms of financing that are counted by credit rating agencies as economic capital.

The difference between equity and debt in the case of liquidation, liquidation or insolvency of a company becomes particularly obvious. For while the insolvency administrator, for example, can still demand outstanding equity capital from the shareholders for payment to the insolvency estate, lenders can extraordinarily terminate the loan granted to the company as debt capital and belong to the regular insolvency debtors of a procedure.

Borrowed capital is recognized on the liabilities side, broken down into liabilities and provisions in accordance with Section 266 HGB. The balance sheet must also provide information on the origin and maturity of the debt. Short-term debt must be repaid within one year, such as overdraft facilities or advance payments received. For long-term debt, the term is usually over five years, so the money is available to the company in the longer term. Loans are usually in this category. Maturities in between count towards medium-term debt. The advantage of debt financing is tax deductibility, and profits do not have to be distributed to outside capital providers. In summary, these are the criteria for debt:

  • Debt relationship: Unlike equity, debt capital generates only a debt and no equity interest.
  • Liability: While shareholders, depending on the legal form of the company, are liable at least with their equity contribution, there are no external lenders.
  • Profits: Shareholders participate pro rata in the profits made. Debtors receive principal and interest, regardless of success.
  • Voting rights: Debt capital does not constitute co-determination in the company.
  • Temporal Bond: Borrowing is granted for a certain period of time.
  • Taxes: The interest on debt capital can be claimed for tax purposes.
  • Rank: In the event of bankruptcy or liquidation, debt capital loans can be terminated extraordinarily. The investor is, unlike the shareholder, a normal creditor and not subordinate.

debt ratio

debt ratio

Borrowing naturally plays a major role in assessing the economic power of companies. The debt ratio is one of the most important balance sheet ratios. It results from the fact that borrowed capital and total balance sheet total are related. A high level of debt capital means that the company is largely financed externally. This increases the income risk, as large portions of the profits are tied to redemption and interest payments. Conversely, a low leverage ratio increases the creditor’s security, as a loss of their receivables and a liquidity shortage are unlikely.

The quota varies greatly depending on the industry in which the company operates. For example, banks have by far the highest debt capital ratio, averaging 85 percent, while the automobile industry accounts for just under 40 percent of the balance sheet total. The leverage ratio is also important in economic terms. Thus, during the banking crisis, the exceptionally high leverage ratio of banks became a problem that was no longer able to hedge their high-risk non-performing loans themselves.

Lending to states is also dependent on their leverage ratio. The debt ratio is one of several criteria that investors use to make their decisions. However, a low quota does not always mean solvency, because even companies or states that no longer receive borrowed funds due to their economic problems will ultimately have a low debt capital ratio.

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