Debt Capital –
simply explained

Key facts at a glance:

• Debt capital is available to a company for a limited period and must generally be repaid together with interest within an agreed timeframe.

• It is used in situations such as purchasing goods, making major acquisitions, during growth phases or in the context of business succession.

• A whole range of financing models is based on debt capital. These include business loans, overdraft facilities or purchase financing.

• Borrowed capital can help increase liquidity, unlock tax advantages, preserve equity and maintain the company's independence.

What Is Debt Capital?

Debt capital is available to a company for a limited period. It comes from third-party capital providers and must be repaid accordingly. The debt capital providers are referred to as "creditors". Debt capital itself is often also called "debt" or "liability".

It is the opposite of equity and is recorded on the liabilities side of the company balance sheet. Borrowed debt capital must be repaid to a lender together with interest after an agreed period. A distinction is made between short-term, medium-term and long-term debt capital.

Debt capital that is only made available to a company on a short-term basis must be repaid within one year. A medium-term liability must be settled within five years, while long-term debt capital allows repayment periods of up to ten years or sometimes even longer.

With repayment and interest, the debt is generally fully discharged — for the money lent, a creditor does not receive any say in the company. Together with equity, debt capital constitutes the total capital of a company. The debt ratio — i.e. the percentage share of external funds — can be calculated as follows:
Debt capital / Total capital x 100 = Debt ratio in percent

What Types of Debt Capital Exist?

Depending on how a debt arises, there are many forms of debt capital. It is roughly divided into two categories: provisions and liabilities to third parties. Liabilities usually represent one of the largest items on a company's balance sheet, as this includes all loans, credits or other forms of debt financing.

So-called provisions are also counted as part of a company's debt capital, even though these "assumed" liabilities are not currently due for payment. This type of debt capital includes expenses whose amount cannot yet be estimated. For example: future taxes, pension obligations or upcoming commissions.

How Can Debt Capital Be Used?

Borrowed capital can provide liquidity in various situations. This allows expenditures to be made that usually cannot be realised through equity alone — for example, when materials need to be purchased for new orders or major acquisitions such as machinery are pending.

With clever financial planning, the so-called leverage effect can also be exploited. If the financing costs are lower than the return on an investment, it can be worthwhile, for instance, to cover the production costs of a product through debt capital and thus generate more profit from its sale.

Debt capital can also offer a tax advantage, as incurred interest is often tax-deductible. With this type of capital, companies also remain more independent: debt capital providers generally do not acquire a share in the company and are not entitled to participate in decisions or share in profits.

Examples of Debt Capital Financing

Debt capital is offered by various providers. When it comes to business loans for medium-sized enterprises, online lending platforms like Teylor have become increasingly prominent alongside traditional banks in recent years. Such corporate loans are widely used as medium- to long-term financing for fixed assets. Other uses include, for example, order pre-financing, growth or investment financing as well as discount financing.

Overdraft facilities also represent a form of debt capital financing. Here, an account holder agrees a credit limit with their lender, up to which they may temporarily overdraw the account. This is suitable, for example, for responding to seasonal fluctuations as part of short-term liquidity planning.

Companies can also use debt capital in the form of so-called purchase financing. In this case, an independent finetrader pre-finances the purchase price of an acquisition. The company pays the outstanding amount, including a service fee, to the intermediary at a later date.

This explanation of the term "debt capital" is part of the Business Loan Knowledge, provided by Teylor AG.