Sometimes it can take years for the light to go on, for me to grasp a concept.
I was brought up to believe that debt is bad. Don’t spend more on your credit card than you can afford to pay off each moth. Don’t buy and finance a new car unless you have the ability to make the payments for the four or five years and then drive the vehicle for another four or five years after it is paid off. Don’t buy a house unless you can afford the 30-year fixed. Pay off all debts as quickly as possible. Make extra payments where you can. Pay off debts as fast as possible to save money on interest.
I never understood, until now, why it is better for a business to carry debt. I remember in my undergrad finance class my professor telling us that debt can be good I flat-out didn’t believe him. I answered the questions the way he wanted, got a decent grade in the class, but his lectures didn’t change my fundamental belief system.
I don’t claim to have a complete understanding of why businesses should carry debt, but the light is starting to come on. I am taking a class right now called “Maximizing Shareholder Wealth”. I am currently reading about capital structure and how to determine the ideal amount of debt for a firm. Interest on debt decreases a firm’s taxes, therefore increasing the overall value of a firm. However, there is a point at which this ceases to be true. With debt comes added risk. The more debt a firm has the higher their risk of default.
The bottom line is to find the balance between a capital structure of debt and equity. I am learning how to compute that “break-even point” but I’m still trying to figure it all out. The light is coming on though. This is a tough topic for me because it goes against my personal belief system. As I learn, I grow.
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