What Is Funded Debt?

Debt financing is an inevitable choice for enterprises to raise funds under the conditions of a market economy. However, this financing method will bring huge potential to the enterprise, but also bring some potential risks. It is generally believed that an enterprise can only maximize its value under the best capital structure. This article analyzes the positive and negative effects of debt financing from a financial perspective, with a view to determining the optimal capital structure of an enterprise.

Debt financing

interest

Continued growing liabilities will eventually lead to

1. Generally speaking,

Financial management is an important part of enterprise management, and it is the management work related to fund raising and effective use. In other words, the collection and use of funds constitute the main content of financial management. At present, the channels for Chinese enterprises to raise funds are divided into equity funds and borrowed funds. With the promulgation of the new "Securities Law", the thresholds for companies to issue shares and go public have been lowered. Many companies have raised funds through the stock market. There is no doubt that equity financing has no expiration date, no return, and no fixed dividend burden (preferred shares) (Except), the financing risk is small, reflects the company's strength, can improve the company's reputation and other advantages, but maintaining a reasonable funding structure plays an important role in achieving corporate financial goals, debt levels have an important impact on corporate value, and debt financing in corporate finance The role cannot be ignored.

I. Financial leverage effect of debt management

Regardless of the company's operating profit, the interest on debt is usually the same. When the profit before interest and taxes increases, the fixed financial costs borne by every 1 yuan of surplus will be relatively reduced, which can bring more surplus to ordinary shareholders; Conversely, when the profit before interest and taxes decreases, the fixed financial costs borne by every 1 yuan of surplus will relatively increase, which will greatly reduce the earnings of ordinary shareholders. This financial leverage effect due to the existence of fixed financial expenses requires the enterprise to maintain a reasonable level of debt and conduct moderate debt operations.

Second, the tax-saving function of liabilities

Corporate liabilities pay interest on schedule. According to the current income tax laws, corporate interest expenses are allowed to be deducted before tax. Under the condition of obtaining the same operating profit, compared with non-liability companies, companies operating with liabilities are less burdened with income tax and receive relative income.

Impact of debt financing on capital structure

The starting point of modern capital structure research is the MM theory proposed by two American scholars, Modiglianit and Miller. The original MM theory believed that capital structure had nothing to do with corporate value under certain strict assumptions. However, some assumptions cannot be established in practice. For example, without corporate and personal income tax, the market is perfect and there are no arbitrage factors. Therefore, the conclusions derived from the early MM theory are not completely in line with reality and can only be used as capital structure The starting point for research. Since then, on the basis of the MM theory, conditions have been relaxed, and after several developments, a tax-benefit benefit-bankruptcy cost trade-off theory has been proposed. The theory holds that: liabilities can bring tax sheltering benefits to enterprises; when the debt ratio does not exceed the level of debt when bankruptcy costs become important, bankruptcy costs are not obvious, and when the debt ratio reaches the level of liabilities when bankruptcy costs become important, The asylum benefit of the liability tax amount starts to be offset by the bankruptcy cost. When the debt ratio reaches the optimal capital structure, the asylum benefit of the marginal liability tax amount is exactly equal to the marginal bankruptcy cost, and the enterprise value is the largest and reaches the optimal capital structure.

Incentives and Constraints on Liability Financing for Shareholders and Managers

Both shareholders and creditors provided the company with financial resources, and ownership was separated from operating rights. On this basis, agency costs were incurred. Managers have the enthusiasm for pursuing additional consumption, which will bring losses to the company and deviate from shareholders' goals, while debt financing will increase the manager's relative holdings and encourage them to work hard, thereby reducing agency costs. In addition, in debt financing, creditors often protect their rights through contracts and laws. If the debt expires, the creditor's rights cannot be realized, and the creditor will realize the power through mandatory measures such as processing collateral and applying for debtor bankruptcy. In this way, the manager For your social reputation and stable career, you must work hard to ensure that you have sufficient free cash flow when debts mature.

V. Risks and prevention of debt financing

To obtain the financial leverage effect from debt management, an enterprise must bear financial risks. For an enterprise to carry out debt financing, the income of the invested project must be greater than the cost of capital; otherwise, the company's cash flow will not be maintained. If the loss is greater than the depreciation amount, it will soon go bankrupt without additional funding. Second, debt financing also bears the risks posed by changes in interest rates, the structure of liabilities, and the success or failure of operations. In order to achieve financial management goals, enable enterprises to survive, develop, profit, and maximize their value, it is necessary to properly use debt management to bring benefits to the enterprise, but also to establish risk awareness and take effective measures to prevent risks: establish an effective risk prevention mechanism Determining the debt ratio reasonably and operating with moderate debt; earnestly studying the relationship between supply and demand in the capital market, analyzing the trend of interest rate changes, formulating a debt financing plan based on its own situation, and maintaining a reasonable debt structure.

In financial management, financial personnel must constantly maintain communication and communication with business personnel, establish a coordinated and cooperative relationship, and monitor each other, and encourage and constrain business personnel by establishing an effective performance evaluation mechanism. Whether it is debt financing or equity financing, it cannot create value for the enterprise itself. Only by investing funds in the project and obtaining a positive net present value can it create value for the enterprise. This is also the practical application of agency theory.