As an investor, you’ll probably look at many different financial records to see if a company is a worthwhile investment. But what does it mean to you if you invest in a company where it has borrowed money from several banks (a.k.a indebted companies)? Here are a few things to consider.
How much debt does the company currently have?
If a company has absolutely no debt, then taking on some debt might be beneficial because it can give the company more opportunity to reinvest resources into its operations. However, if the company in consideration already has a substantial amount of debt, you might want to think twice. Generally, too much debt is a bad thing for companies and shareholders because it inhibits a company’s ability to create a cash surplus. Furthermore, high debt levels might negatively affect common stockholders, who are last in line for claiming payback from a company that becomes insolvent.
See also: How to Prevent Startup from Collapsing
What kind of debt is the company in question taking on?
Loans and fixed-income securities that a company issues differ dramatically in their maturity dates. Some loans must be repaid within a few days of issue, while others don’t need to be paid for several years. Typically, debt securities issued to the public (investors) will have longer maturities than the loans offered by private institutions (banks). Large short-term loans might be harder for companies to repay, but long-term fixed-income securities with high interest rates might not be easier on the company. Try to determine if the length and interest rate of the debt is suitable for financing the project that the company wishes to undertake.
What is the debt for?
Is the debt meant to repay or refinance old debts or is it for new projects that have the potential to increase revenues? Typically, you should think twice before purchasing stock in companies that have repeatedly refinanced their existing debt, which indicates an inability to meet financial obligations.
Can the company afford the debt?
Most companies will be certain of their ideas before committing money to them; however, not all companies succeed in making the ideas work. It is vital that you determine whether the company can still make its payments if it gets into trouble or its projects fail. You should look to see if the company’s cash flows are sufficient to meet its debt obligations. And make sure the company has diversified its prospects.
Read also: Volkswagen and 9 Other Most Indebted Companies on Earth