Lowering DEBT Leads To Better Performance

Debt is a perfect example of the proverbial two-edged sword. The clever use of leverage can boost the returns a company generates for its shareholders to a large extent; however, it is difficult to carry a large amount of debt successfully in a tough economic condition. Lately, we have seen a number of companies lowering their debt levels. Join us as we go about finding out what is the right capital structure and analysing the performance of certain companies that have moved away from debt

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For a business to continue to be successful, it has to invest in new plant and equipment to generate additional revenues. This is the fundamental basis for driving future growth. Finding sources for funding is perhaps one of the most important decisions the management of a company has to take to finance its assets, day-to-day operations and future growth. From a tactical perspective, the capital structure of a company influences everything from a firm’s risk profile, the return its investors expect and its degree of insulation from macroeconomic factors.

One way to pay for these investments is to generate capital from the firm’s operations. The earnings a firm generates can either be distributed as a cash dividend or ploughed back into the firm. But more often than not, the retained earnings of a firm are insufficient to support profitable investment opportunities. In that case, a firm is faced with a decision: to raise new capital either by borrowing (incurring debt) or by selling additional ownership (equity). The combination of the two used to finance a company’s projects is called the capital structure. Hence the capital structure of a firm is a mix of debt, internally generated funds and new equity. But what is the right mixture?