Debt financing
In one sentenceThe business obtaining funds from a financier or lender that it must repay with their cost on set dates, without the financier receiving a stake in ownership.
Simply put
Its advantage is that you keep full ownership and its cost is set in advance. Its drawback is that the installments must be paid even in weak months.
Islamic financing (murabaha, ijara…) is also recorded in the accounts as a liability of the business, and its cost is treated as a financing cost.
Worked example
A spare parts store needs 500,000 SAR to expand, and obtained financing at an annual cost of 8%; its expected profit after the expansion is 400,000 SAR before financing cost.
Annual financing cost500,000 × 8% = 40,000 SAR
Owner's share of ownership100%
What remains for the owner = 400,000 − 40,000360,000 SAR
Don't confuse it with
Equity financingIt has no installments, but the new partner takes a share of the profits every year and of the business's value.