Debt

Debt is that which is owed; usually assets owed, but the term can also cover moral obligations and other interactions not requiring money. In finance, debt is a means of using anticipated future purchasing power in the present before it has actually been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.

A debt is created when a creditor agrees to lend a sum of assets to a debtor. In modern society, debt is usually granted with expected repayment; in most cases, plus interest.

Etymology

The word comes from the French dette and ultimately Latin debere (to owe), from de habere (to have). The letter b in the word debt was reintroduced in the 17th century, possibly by Samuel Johnson in his Dictionary of 1755— several other words that had existed without a b had them reinserted at around that time.

Payment

Before a debt can be made, both the debtor and the creditor must agree on the manner in which the debt will be repaid, known as the standard of deferred payment. This payment is usually denominated as a sum of money in units of currency, but can sometimes be denominated in terms of goods or services. Payment can be made in increments over a period of time, or all at once at the end of the loan agreement.

Types of debt

A company uses various kinds of debt to finance its operations. The various types of debt can generally be categorized into: 1) secured and unsecured debt, 2) private and public debt, 3) syndicated and bilateral debt, and 4) other types of debt that display one or more of the characteristics noted above.

A debt obligation is considered secured, if creditors have recourse to the assets of the company on a proprietary basis or otherwise ahead of general claims against the company. Unsecured debt comprises financial obligations, where creditors do not have recourse to the assets of the borrower to satisfy their claims.

Private debt comprises bank-loan type obligations, whether senior or mezzanine. Public debt is a general definition covering all financial instruments that are freely tradeable on a public exchange or over the counter, with few if any restrictions.

A basic loan is the simplest form of debt. It consists of an agreement to lend a principal sum for a fixed period of time, to be repaid by a certain date. In commercial loans interest, calculated as a percentage of the principal sum per year, will also have to be paid by that date.

In some loans, the amount actually loaned to the debtor is less than the principal sum to be repaid; the additional principal has the same economic effect as a higher interest rate (see point (mortgage)), and is sometimes referred to as a banker's dozen, a play on "baker's dozen" – owe twelve (a dozen), receive a loan of eleven (a banker's dozen). Note that the effective interest rate is not equal to the discount: if one borrows $10 and must repay $11, then this is ($11–$10)/$10 = 10% interest; however, if one borrows $9 and must repay $10, then this is ($10–$9)/$9 = 11 1/9 % interest.

A syndicated loan is a loan that is granted to companies that wish to borrow more money than any single lender is prepared to risk in a single loan, usually many millions of dollars. In such a case, a syndicate of banks can each agree to put forward a portion of the principal sum. Loan syndication is a risk management tool that allows the lead banks underwriting the debt to reduce their risk and free up lending capacity.

Debt syndication

Cash Credit

This is the primary method in which banks lend money against the security of commodities and debt. It runs like a current account except that the money that can be withdrawn from this account is not restricted to the amount deposited in the account. Instead, the account holder is permitted to withdraw a certain sum called "limit", "credit facility" in excess of the amount deposited in the account. Cash Credits are, in theory, payable on demand. These are, therefore, counter part of demand deposits of the Bank.

Working capital:

Firms need cash to pay for all their day-to-day activities. They have to pay wages, pay for raw materials, pay bills and so on. The money available to them to do this is known as the firm's working capital. The main sources of working capital are the current assets as these are the short-term assets that the firm can use to generate cash. However, the firm also has current liabilities and so these have to be taken account of when working out how much working capital a firm has at its disposal.

Working capital is therefore Current Assets (stock + debtors + cash) minus Current liabilities. Working capital is the same as net current assets, and is an important part of the top half of the firm's balance sheet. It is vital to a business to have sufficient working capital to meet all its requirements. Many businesses have undergone bankcruptcy, not because they were unprofitable, but because they suffered from a shortage of working capital.

Bank Overdraft:

The word overdraft means the act of overdrawing from a Bank account. In other words, the account holder withdraws more money from a Bank Account than has been deposited in it. An overdraft occurs when withdrawals from a bank account exceed the available balance which gives the account a negative balance - a person can be said to be "overdrawn".

If there is a prior agreement with the account provider for an overdraft protection plan, and the amount overdrawn is within this authorised overdraft, then interest is normally charged at the agreed rate. If the balance exceeds the agreed terms, then fees may be charged and higher interest rate might apply

Term loan:

Term Loan are the counter parts of Fixed Deposits in the Bank. Banks lend money in this mode when the repayment is sought to be made in fixed, pre-determined installments. This type of loan is normally given to the borrowers for acquiring long term assets i.e. assets which will benefit the borrower over a long period (exceeding at least one year). Purchases of plant and machinery, constructing building for factory, setting up new projects fall in this category. Financing for purchase of automobiles, consumer durables, real estate and creation of infra structure also falls in this category.

Bill discounting:

Bill discounting is a major activity with some of the smaller Banks. Under this particular type of lending, Bank takes the bill drawn by borrower on his(borrower's) customer and pay him or her immediately deducting some amount as discount/commission. The Bank then presents the Bill to the borrower's customer on the due date of the Bill and collect the total amount. If the bill is delayed, the borrower or his customer pay the Bank a pre-determined interest depending upon the terms of transaction.

Project Financing:

Project finance is the financing of long-term infrastructure and industrial projects based upon a complex financial structure where project debt and equity are used to finance the project, rather than the balance sheets of project sponsors. Usually, a project financing structure involves a number of equity investors, known as sponsors, as well as a syndicate of banks that provide loans to the operation.

Non Fund Base

The LC can also be the source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and a document proving the shipment was insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.