How to Fund Capital Spending With Debt

Bank loans are a common financing method for capital spending.

Businesses often use external financing to pay for assets or other large capital outlays. This prevents the use of cash generated from daily operations, which is primarily for paying operational bills. Capital spending is the business term relating to large-scale purchases. A common source of external financing is debt from banks or other lenders. Companies will review the needed capital and best possible source of funding. This ensures the company maximizes its benefit from bank debt and minimizes its exposure to business risk.

Instructions

1. List the items that require capital spending funds. Owners and managers will likely need to pick one project from several choices when securing external funds.

2. Calculate the cost of capital. Banks assign interest rates to each loan. The interest payments made above principal repayment are the cost of capital a company pays for using borrowed money.

3. Review the loan terms from each bank. Terms can vary for business loans. Length, interest rate, repayment terms and default procedures can affect loan agreements.

4. Select the loan for the capital spending project. The business owner will typically sign the agreement and receive the capital into the company's bank account.

5. Purchase the item needed for the business or begin the project. Major purchases will often require spending the funds at one time, whereas projects may require periodic payments over time.

6. Create a repayment plan. Based on the loan agreement, companies will need to ensure they set aside income from business revenues to repay the loan.

Tips & Warnings

• Other financing options may exist for capital spending. For example, large organizations can issue bonds or stock. Saving cash from operations is another option.

• Smaller businesses may struggle to repay bank loans. These companies typically have smaller market share, lower cash flows and are more susceptible to changes in consumer behavior.

References

• "Essential Economics"; Matthew Bishop; 2009