Debts are bad, but not always. We can give you multiple reasons as to why debts can be good- why it is only prudent on the part of businesses to be financed by debts. There are several opportunities to be seized.
Image via Flickr
Why are business debts not that bad?
The tax deductions might as well end up acting as one of the major reasons why businesses would want to have debts. Corporate tax rebates can be described as a potent means by the help of which government goes on to encourage businesses to have debts. Don’t you think it’s more than enticing to have substantial rebates on corporate taxes tipped at 35%? Thanks to these deductions, a company’s cost of debt might as well end up being below 5% after the tax break along with the rate of interest is considered.
Business debts encourage faster growth as well. Let us consider the example of two businesses in a situation where both these businesses make profits worth $20,000. Now both of them can add to their profits by investing in equipment worth $2, 20, 000. the first business waits for a year to make the required savings – assuming that they can make the best use of the opportunity in the year ahead without incurring debts.
The second company, on the other hand, decides to leverage its existing profits, secures a debt, purchases the required equipment, and chalks out a solid scheme to use the additional earnings from the equipment to repay the debts. Needless to say, the growth process of the second company starts way before that of the first company. The second company gets a whole extra year to work on its growth plans.
Business Debts are far better options than Equity
Another reason why businesses turn to debts is that they (i.e. debts) are much cheaper than equity. Debts are way less risky than equity. Typically, a company has no legal obligation to pay off dividends to the stakeholders. Additionally, shareholders are the first people to lose their money when a business goes bankrupt. There is no such risk associated with debts- owing to the very simple fact that companies are legally obligated to pay off debts. When it comes to returns on equities, much of them are associated with stock appreciation. An investor goes on to charge at least 10% of the returns. Debts are definitely cheaper.
Leave a Reply