PERDIZO, MILJANE P.

BSA III

Debt Analysis
Pros
 Interest Payments are Tax Deductible

Interest on debt financing is deductible as a business expense. This is one of

the features that makes debt financing more appealing than equity financing. If the
business's marginal tax rate is 25%, for example, interest charges shield the
percentage of revenue. The interest you pay on your mortgage is not tax deductible

 Regulation by the Management

When you borrow money from a bank or another investor, you become
obliged to make the agreed-upon installments on time, so that's it. Without outside
intervention from private investors, you maintain the freedom to run your company
as you see fit.

 Interest Rate reduction

The cost of equity funding will be higher than the cost of debt financing.
Since interest rates are tax deductible, the interest rate on a mortgage loan or other
type of debt finance would be lower than the cost of equity.

 Accessibility 

Small companies can get debt financing more easily than they can get equity
financing. For example, only 0.08 percent of small companies ever seek equity
funding from venture capital firms. The majority of small companies are largely
reliant on debt funding. Debt lending comes in many ways, from bank loans to
merchant cash advances. Debt funding isn't a one-size-fits-all solution.

 Credit ratings for a business

 Debt funding can seem to be detrimental to companies and no one enjoys
being in debt. Businesses may increase their business credit score by
demonstrating creditworthiness in debt management, such as making on-time
payments.

 There will be no Profit Sharing 

There is no benefit share if the company uses loan finance and there are no
buyers. Profits are not required to be shared with borrowers by businesses. The
benefit can be kept by the company owner and distributed as desired.

Cons

 Return of Funds 

If a company uses loan finance to borrow money, it must pay it back.

Regardless of their cash flow condition, they must repay principal and interest.
And if the company goes out of business, the loan must be paid. When you're
pushed into debt, the lenders will have a demand for redemption before your stock
holders.

 Cash Flow 

A business's cash flow would be harmed if it relies too much on loan

servicing so principal and interest payments must be paid on the debt. A company's
debt-to-equity ratio can be used to assess its focus on debt funding and equity
financing. It's preferable if the ratio is as poor as possible. One of the most
common issues that small businesses face is a lack of or negative cash flow.

 Collateral 

In order to obtain loan funding, often small companies will be required to

put up collateral. Many company owners are wary of collateral because it often
requires them to use properties that they own individually, such as their houses.

 Credit score 

When the company needs funding, it will seem appealing to keep taking on
loans, a tactic known as borrowing up, but each loan will be noted on your credit
report and will have an impact on your credit rating. Since the lender's liability
increases if you borrow further, you'll pay a higher interest rate for any additional
loan.

 Distinguish between the 1989 Savings and Loan Crisis and the 2007-2012
Great Depression.

In 1989, it was revealed that commercial banks had failed at a higher rate
than in the previous year before the Great Depression. A quick look at the figures
reveals, however, that despite the fact that 206 banks collapsed in 1989, 192 new
banks were created. This can be linked to the approximately 14,000 commercial
banks that operate. There are issues with the commercial banking sector. They are,
though, far from catastrophic in scale. It is becoming painfully clear that the
Federal Deposit Insurance Fund is in jeopardy. This, however, is a political
problem rather than an economic one. The concern is how many bank defaults can
be handled using the accounting entry known as the fund, and how many would
necessitate taxpayer assistance. The S&Ls, on the other hand, lost roughly two-
thirds of their total. Their industry is almost depleted; the depletion of the thrift
insurance fund is barely a concern. The ongoing possibility that thrifts would have
to be replaced by the commercial banking sector for their own safety is an indirect
testament to the industry's overall wellbeing. One might also argue that
commercial banks are on the verge of a recession. However, despite the fact that a
chain of incidents has already devastated the thrift market, the commercial banking
industry has emerged largely unscathed.
They  saw the return of greater central planning in 1989. It seems that there
is moderation in both directions. Relying on either extreme will result in difficulty.
Now, as greater centralized planning seems to be the inevitable solution to the
S&L problem, may be the time to begin a return to the free market for S&L
operations.
“Excessive debt leverage or imprudent lending” is the immediate causes of
the crisis (Wade 2008, p.27). When market turmoil set in after the bankruptcy of
Lehman Brothers, and this massive default risk forced investors to the breaking
point, much of this debt leverage was in the form of complexly arranged credit
instruments, such as the CDS.
Despite signals that the financial recession might not be as serious as the
Great Depression, current economic projections do not indicate a definite route to
growth in the near future. Capitalism has been seen to be vulnerable to crises and
boom-and-bust periods.
While the risk of defaults on the subprime sector when the mortgage bubble
exploded was the most famous, the magnitude of the recession can be explained by
infrastructure failures as well as government intervention shortfalls. Consider the
“sudden stop” in asset-backed securities syndicated loans to major creditors in June
2007.
Other reasons included banks' overreliance on short-term wholesale
financing, flaws in private sector risk control, an overreliance on ratings agencies,
excessive debt among individuals, companies, and financial institutions, legislative
loopholes in special purpose vehicle supervision, and a worldwide lack in current
regulatory procedures (Bernanke 2010).