Benefits of corporate debt management
-Enterprise debt management can effectively reduce the weighted average cost of capital of enterprises. This influence is mainly reflected in two aspects: on the one hand, for investors, the yield of creditor's rights is fixed, and the principal can generally be recovered at maturity, unless the enterprise is insolvent and liquidated. The risk is smaller than equity investment, the required rate of return is correspondingly lower, and the cost of debt financing is also lower than equity financing. Therefore, the cost of debt capital is lower than equity capital. In addition, debt management can benefit from the "tax reduction effect". Because the interest expense of debt is paid before tax, enterprises can get the benefit of reducing income tax. Under the influence of these two factors, when the total amount of funds is fixed, a certain proportion of debt management can effectively reduce the weighted average capital cost of enterprises.
-Debt management brings "financial leverage effect" to enterprises. Because paying interest to creditors is a fixed expenditure that has nothing to do with the profit level of enterprises, when the profit rate of enterprises is higher than the cost of debt funds, the income of enterprises will increase to a greater extent, that is, the financial leverage effect. At the same time, enterprises can use their own funds saved by debt to create new profits. Therefore, a certain degree of debt management plays an important role in improving the profitability of enterprises.
-Debt management can enable enterprises to benefit from inflation. In an inflationary environment, the currency depreciates and prices rise, but corporate debt repayment is still based on its book value, regardless of inflation. In this way, the real value of the enterprise's actual repayment is lower than the real value of the borrowed currency, which makes the enterprise gain the benefit of currency depreciation.
-Debt management is conducive to maintaining corporate control. When an enterprise raises funds, if it raises capital by issuing stocks, it will inevitably lead to the dispersion of equity and affect the control right of existing shareholders. Debt financing can increase the source of enterprise funds without affecting the control of enterprises, which is beneficial to the control of existing shareholders.
-Debt management is also an external supervision factor for the company to improve its governance mechanism. Corporate debt is not only a means of financing, but also can reduce the agency cost of shareholders and managers by optimizing the capital structure and introducing the supervision of creditors. In order to ensure the recovery and appreciation of their own capital, creditors will of course pay attention to the operation of enterprises, which will virtually supervise managers, thus reducing the cost of shareholders' supervision of managers. Debt is not only a means of enterprise financing, but also the introduction of external supervision factors to improve corporate governance mechanism.
Risks of debt management
-The negative effect of "financial leverage effect". When enterprises are faced with operational difficulties caused by economic downturn or other reasons, due to the burden of fixed interest, when the profit rate of funds declines, the return rate of investors will decline at a faster rate.
-Bankruptcy risk. For debt management, the enterprise has the legal responsibility to repay the principal and interest when due. If the enterprise can't get the expected rate of return from the capital investment projects raised by debt, or the overall production, operation and financial situation of the enterprise deteriorate, or the short-term capital operation of the enterprise is improper, these factors will not only lead to a sharp drop in the profit of the enterprise, but also make the enterprise face the risk of insolvency. Therefore, enterprises may be short of funds and forced to auction or mortgage assets at low prices.
-Refinancing risk. Due to debt management, the asset-liability ratio of enterprises increases, the degree of guarantee to creditors decreases, and enterprise investors also demand higher returns because of the increased risks of enterprises. As compensation for possible risks, it will greatly increase the cost and difficulty for enterprises to issue loans such as stocks and bonds to raise funds.
How should enterprises be moderately indebted?