What is Debt Financing?
Debt financing is the act of raising capital by borrowing from banks, bondholders, or sukuk investors with an obligation to repay the principal plus interest or profit by a defined maturity date, contrasted against equity financing.
How It Works
- Short-term sources: bank overdrafts, working-capital lines, trade credit.
- Long-term sources: term loans, sukuk, corporate bonds, leasing.
- Cost: interest or profit rate, often benchmarked to SAIBOR plus a margin.
- Tax-deductible interest in most jurisdictions (zakat treatment differs in Saudi).
Saudi Context
Saudi companies typically tap commercial banks for working capital, the Saudi Industrial Development Fund or Social Development Bank for subsidized term loans, and Tadawul-listed sukuk for long-term capital. Because most Saudi corporates are taxed on zakat (a fixed 2.5% of zakat base) rather than corporate income tax, the tax shield benefit of debt is less pronounced than in CIT jurisdictions.
Example
A Saudi manufacturer takes a SAR 10,000,000 SIDF loan at 2% over 7 years to fund new equipment. Annual interest = SAR 200,000, principal repayment = SAR 1,428,571, total annual debt service = SAR 1,628,571.