In “Why Businesses Use Debt And How Debt Benefits Businesses,” Dr. Rebel Cole, Professor of Finance at DePaul University, argues that “debt enables a company to grow and expand its operations to increase production in a growing market.” He provides an overview of the reasons why a business uses debt to finance a portion of its investments and explains how this is beneficial to the firm. Dr. Cole finds that debt financing is universal as businesses of all sizes, in all sectors, and of all legal forms use debt to finance growth.
Key findings are:
- Accessing the credit markets enables a firm to grow beyond the size of its equity holders’ investments.
- Four out of five businesses use debt to finance at least some portion of the firm’s investments.
- On average, small businesses use one dollar of debt for each one-to-two dollars of equity, but this ratio varies widely across companies by industry, size and organizational form.
- Financial analysts measure how much a firm relies upon debt using leverage ratios. Leverage refers to how much the firm relies upon debt relative to equity financing.
- These leverage ratios vary across firms along a number of different dimensions, including (but not limited to) size and legal form of organization and industry.
- Larger businesses, organized as corporations, and firms in asset-intensive industries (such as manufacturing and transportation) use more debt.
- Debt is also very important for smaller businesses and start-ups. According to the U.S. Small Business Administration, four in five small businesses use some form of debt in their capital structure. In addition, 75% of start-ups use some sort of debt financing at inception and this percentage remains relatively constant over the first five years of their operation. Debt enables the business to respond to funding emergencies that might otherwise force it to shut down.
- Debt enables a company to grow and expand its operations to increase production in a growing market.
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