Advantages of Long-Term Debt Financing

Long-term debt consists of loans and financial obligations lasting over one year. It is classified as a non-current liability on the company’s balance sheet. In accounting, long-term debt generally refers to a company’s loans and other liabilities that will not become due within one year of the balance sheet date.

From the issuing firm’s perspective, the major advantages of long-term debt financing are as follows:

(1) Debt is a least costly source of long-term financing. It is the least costly because:

  • Interest on debt is tax-deductible,
  • Bondholders or creditors consider debt as a relatively less risky investment and require a lower return.

(2) Debt financing provides sufficient flexibility in the financial/capital structure of the company. Flexibility in the capital structure of the company can be increased by inserting call provision in the bond indenture. In case of over capitalization, the company can redeem the debt to balance its capitalization.

(3) Bondholders are creditors and have no interference in business operations because they are not entitled to vote.

(4) The company can enjoy tax saving on interest on the debt.

(5) Long-term debt usually has fixed interest rates that translate into consistent monthly payments and high predictability.

(6) There are a wide variety of long-term debt financing options available to borrowers, such as mortgages, leases, reverse mortgages, and loan refinancing, which can be fine-tuned to meet the borrower’s needs.

From the investor’s point of view, in general, debt securities offer stable returns. Further, if the company is liquidated then debenture holders are paid before preferred stockholders and common stockholders. Bondholders are creditors, however, they do not participate in any increased earnings the firm may experience. Similarly, they do not get the right to vote.

 

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