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6 Things to know about Corporate Debt Borrowing

Tuesday 15 March 2016

By Kotak Securities:



In today's SlideShare, check out the important things you must know about capital structure and corporate debt borrowing.
  1. 6 Things you should know about Corporate Debt Borrowing

  2. It is general knowledge that companies need to borrow money to function. Rarely does it happen that companies generate enough funds to not only meet costs and pay employees but also plan new projects and expand in size. This is where debt and equity come in. This is called the company’s capital structure. This is becoming more relevant today considering the debt problems that Indian companies and banks are facing. Here are six things to know about capital structure:

  3. Cost of debt: Everything comes at a price, even money. Whenever companies borrow money either through bank loans or other assets like Bonds and Debentures, they promise to pay an interest amount on this borrowing. This is the cost of debt. Higher the interest rates, greater is the cost. However, debt gets a tax benefit – the interest paid can be deducted from total income while calculating tax. This essentially reduces the cost of debt.

  4. Cost of equity: It takes a lot of money to list shares in the stock market. Moreover, companies need to find the right price for the shares in the initial public offer. Otherwise, there may not even enough investors. All this forms the cost of equity. Additionally, companies have to pay tax on the dividends distributed to investors. This could also be considered an additional cost for companies.

  5. Debt v/s Equity: Usually, debt is considered a better option than equity. It is considered the cheaper option. Plus, companies have more flexibility when it comes to paying back the debt. Equity, on the other hand, is not as flexible. Also, the cost of equity is often directly proportional to the amount of debt a company has – it increases as a company piles on more debt. This is why analysts look at a newly listed company’s debt while analysing if the shares are worth investing in.

  6. Financial distress: The downside to debt is that it increases a company’s risk. Usually, a company is obligated to pay off its debt first and then pay its equity shareholders. So, whatever money a company earns goes off in paying off costs and interests due. All the money left becomes the company’s profit. This is often reinvested in the company for future growth and expansion. As a company piles on debt, its interest obligation increases. So, if ever the company is in financial distress from lack of sales and revenues, a high debt is detrimental – it only increases its expenses. This is called the cost of financial distress.

  7. Optimal capital structure: This is why debt is good for a company only up to a certain limit. This is called the ‘optimal capital structure’. So how do you measure this limit? The optimal capital structure is when the tax benefits of debt are maximized. The moment the cost of financial distress turns higher than the benefits, the capital structure becomes debt-heavy and risky. This, however, is easier said than done. The cost of financial distress is not easy to measure.

  8. Measuring risk: This is where credit ratings come in. Agencies like CRISIL, CARE Ratings and Moody’s measure a company’s ability to repay. This is called as credit risk. Based on this analysis, the agencies assign the company’s debt a credit rating. Any change in the rating influences the cost of borrowing for the company. This also affects the company’s share price. So if a rating is downgraded, share prices can fall. This increases the overall cost for the company and minimises any tax benefits.
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Disclaimer: Kotak Securities Limited. Registered Office: 27 BKC, C 27, G Block, Bandra Kurla Complex, Bandra (E), Mumbai 400051. CIN: U99999MH1994PLC134051, Telephone No.: +22 43360000, Fax No.: +22 67132430. Website: www.kotak.com. Correspondence Address: Infinity IT Park, Bldg. No 21, Opp. Film City Road, A K Vaidya Marg, Malad (East), Mumbai 400097. Telephone No: 42856825. SEBI Registration No: NSE INB/INF/INE 230808130, BSE INB 010808153/INF 011133230, MCXSX INE 260808130/INB 260808135/INF 260808135, AMFI ARN 0164 and PMS INP000000258. NSDL: IN-DP-NSDL-23-97. CDSL: IN-DP-CDSL-158-2001 Investments in securities are subject to market risk; please read the SEBI prescribed Combined Risk Disclosure Document prior to investing. Derivatives are a sophisticated investment device. The investor is requested to take into consideration all the risk factors before actually trading in derivative contracts. Compliance Officer Details: Mr. Manoj Agarwal. Call: 022 - 4285 6825, or Email: ks.compliance@kotak.com. In case you require any clarification or have any concern, kindly write to us at below email ids:
  • Level 1: For Trading related queries, contact our customer service at 'service.securities@kotak.com' and for demat account related queries contact us at ks.demat@kotak.com or call us on: Online Customers – 30305757 (by using your city STD code as a prefix) or Toll-free numbers 18002099191 / 1800222299, Offline Customers – 18002099292.
  • Level 2: If you do not receive a satisfactory response at Level 1 within 3 working days, you may write to us at ks.escalation@kotak.com or call us on 022-42858445 and if you feel you are still unheard, write to our customer service HOD at ks.servicehead@kotak.com or call us on 022-42858208.
  • Level 3: If you still have not received a satisfactory response at Level 2 within 3 working days, you may contact our Compliance Officer (Name: Manoj Agarwal) at ks.compliance@kotak.com or call on 91- (022) 4285 6825.
  • Level 4: If you have not received a satisfactory response at Level 3 within 7 working days, you may also approach CEO (Mr. Kamlesh Rao) at ceo.ks@kotak.com or call on 91-(022) 6652 9160.

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