Debt Definition and Example
Debt Definition – Money owned to creditors.
It is the money that the company owes to the creditors. Moreover, it is an agreement between lender and the company has to return it after a certain period with interest on the borrowing at regular intervals of time. The purpose of debt may vary. Some organisation take debt for expansions purpose, some for meeting operation needs and some for purchasing the capital assets. In addition to this, companies also take debt for buy back of shares.
In case, organisations are unable to pay the debts, then the organisation assets are used to repay the debt. However debt is an unsecured security. But the main issue comes at the time of taking debt, Creditors provides the debt by studying the financial statements of the company. The most important thing to note is that, if the company breach the agreement then the creditors have the power to call off the loans and advances provided to the organisation.
There are lots of debt instruments available in the market through which companies can raise the funds. These are –
Bonds – Bond is an instrument issued by the company in which the investor agrees to pay the certain amount of money in exchange of a fixed interest rates. Companies issue bonds at different rates of interest. Investors buy as they get principal amount as well as the interest on the due date.
Debenture – Just like bonds, debenture is an instrument which is a promise of the issuer that after certain date, he will pay the amount of principal to the lender. In addition to this, interest at regular interval is also given to the lender. The main difference between debenture and bond is that bonds are more secured However the rate of interest on bond is comparatively lower.
Commercial Papers – It is a short term money raising instrument which can be issued by only those companies who have high ratings. These papers are issued at discount and buy back at the face value. The difference between the discount rate and par value is the profit of the lender.
Loans – Banks and various other financial institutions provides loans to the organisation. They are secured form of debts. Loans are backed by some security. Security could be any asset that has value more than the loan amount.
Related Financial Terms of Debt
- Return on Equity Definition – ROE Meaning and Importance
- Valuation Definition – Procedure and Importance