Advantages of Organizational Structure
Advantages of Organizational Structure
The Advantages of Using Debt as Capital Structure by Jay Way, Demand Media
Companies often use debt when constructing their capital structure, which helps lower total financing cost. In addition to the relatively lower cost of debt financing, using debt has other advantages compared to equity financing, despite potential issues that using debt may cause, such as ongoing financial liabilities and potential bankruptcy risk. In general, using debt helps keep profits within a
Cost Reduction
Compared to equity, debt requires lower financing cost. Thus, companies often mix debt into their capital structure to bring down the average financing cost. Using debt, companies are contractually liable to make periodic interest payments and return debt principal at maturity. As a result, debt holders bear less risk, compared to equity holders, who often have no recourse for their investments if companies fail. In the event of a company liquidation, debt holders also have the senior claiming rights to company assets, which gives them another layer of protection for their investments. Therefore, a safer debt investment requires less cost compensation.
Profit Retention
While using debt may add pressure to a company’s ongoing operations as a result of having to meet interest-payment obligations, it helps retain more profits within the company compared to using equity, which requires the sharing of company profits with equity holders. Using debt, companies need to pay only the amount of interest out of their profits. Using equity, on the other hand, the more profits a company makes, the more it has to share with equity investors. To take advantage of such a debt-financing feature, companies often use debt to finance stable business operations in which they can more easily make ongoing interest payments and, meanwhile, retain the rest of the profits to themselves.
Financial Leverage
Using debt is also advantageous to existing owners because
The Advantages of Using Debt as Capital Structure by Jay Way, Demand Media
Companies often use debt when constructing their capital structure, which helps lower total financing cost. In addition to the relatively lower cost of debt financing, using debt has other advantages compared to equity financing, despite potential issues that using debt may cause, such as ongoing financial liabilities and potential bankruptcy risk. In general, using debt helps keep profits within a
Cost Reduction
Compared to equity, debt requires lower financing cost. Thus, companies often mix debt into their capital structure to bring down the average financing cost. Using debt, companies are contractually liable to make periodic interest payments and return debt principal at maturity. As a result, debt holders bear less risk, compared to equity holders, who often have no recourse for their investments if companies fail. In the event of a company liquidation, debt holders also have the senior claiming rights to company assets, which gives them another layer of protection for their investments. Therefore, a safer debt investment requires less cost compensation.
Profit Retention
While using debt may add pressure to a company’s ongoing operations as a result of having to meet interest-payment obligations, it helps retain more profits within the company compared to using equity, which requires the sharing of company profits with equity holders. Using debt, companies need to pay only the amount of interest out of their profits. Using equity, on the other hand, the more profits a company makes, the more it has to share with equity investors. To take advantage of such a debt-financing feature, companies often use debt to finance stable business operations in which they can more easily make ongoing interest payments and, meanwhile, retain the rest of the profits to themselves.
Financial Leverage
Using debt is also advantageous to existing owners because