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Debt. Good or bad?

Buying a company with high debt?


Debt, is simply something that is owed. For a company, debt usually happen in monetary form. Just like company A owes a debt of RM10 million from the bank. Debt, is something that need to be returned to the owner. Normally, interest is applied on the debt.
So how does debt occur in a company? When does a company need to get some financial support externally? This could happen during company’s company expansion or when company goes into financial hardship.
At this time, a company need more money to turnover their operation. Now, you might argue that if a company is strong enough, it should have sufficient cash flow to support itself. So the question here is if debt for sure, a bad thing?

No. It depends on situation. First of all, let’s discuss about the disadvantages of having debt. Having debt means having the necessity to incur extra expense on interest fee. Imagine this yourself, will you borrow RM10,000 to a friend for 1 year without any interest? I am sure it is a no, or at most, you might still be hesitating to borrow or not. But what if he promised to return to you RM12,000 after a year? The same happened to bank and company. There won’t be any bank that lend money for free to company. Of course, they will ask for interest fee in return. So, the more debt a company has, the larger the interest fee that a company has to incurred. Theoretically, having debt is bad.
How can debt helps a company to grow?


But it is not always that way. Imagine Company A identify a business opportunity that requires RM1 million to startup. This project is expected to bring about a 30% return annually and can be executed immediately. However, the company has insufficient cash flow to support the project. So, the company decides to get a loan from the bank, which is charged at 8% interest annually. In this scenario, is debt still a bad thing? Nope, it is a good investment as the ROR from project could fully cover the interest rate, in addition it generates extra income to the company.

The conclusion today is that as long as a company is confident to generate return higher than interest fee, having debt is not totally a bad thing. In fact, you will realise that plenty big companies prefer to take loan from bank for projects, rather than using their available free cash flow. This is because they (1) know that the ROR of project is higher (2) do not want to miss any profitable project that is more urgent and need cash immediately. After all free cash is still the most liquid assets. All in all, debt is not necessarily a bad thing. A good company should always take on debt and invest them wisely to gain maximum return for the company. Nevertheless, if a company's debt is increasing year by year, and the company fails the current ratio test, then you should be alert. 
Good debt is a powerful tool. But bad debt can kill you. - Robert Kiyosaki

In fact, sometimes, it is the company with excessive cash reserve that you should be aware and stay away from.

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