This month ... 'since the banking crisis, many companies are aiming to become debt free. But debt is a cheap form of finance, so what should I recommend to my CEO?'.
| Author | Soskin, David |
| Position | CIMA and an entrepreneur answer your questions |
CIMA versus David Soskin
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CIMA
The tax benefits of debt interest payments, according to the theory at least, make debt a relatively cheap form of finance. So if your organisation is profit making, and those profits are taxable and your tax jurisdiction treats interest paid on debt financing as tax deductible, then debt is probably significantly cheaper than raising equity finance.
However, the 2008 financial crisis and ensuing period of slow growth have left many banks unwilling to lend, while some companies are averse to borrowing and don't want to depend on the banks for financing new projects. Indeed, many are now hoarding hefty cash reserves.
For some, this is not a new phenomenon. Mastercard, Amazon and Apple have all famously issued zero debt, but in 2012 several previously indebted companies followed suit. In the UK, building giant Persimmon announced its intention to remain largely debt free, in the medium term at least.
But moving away from having incurred debt from borrowed capital towards becoming debt free is challenging. Your CEO and CFO need to have a detailed knowledge of the company's finances. Without a thorough understanding of costs and expenditure, as well as the business's real profitability, the liquidity risk will be high. They must also ensure your organisation has and is using an operations budget, implemented alongside a comprehensive cash flow management strategy. The process will require a holistic operational rethink if the company is going to pay off existing debt by reducing costs and increasing cash flow.
Despite these challenges it is worth remembering that during periods of slow economic growth, the less debt an organisation holds the more likely it is to survive the storm. And when economic growth kick-starts, debt-free organisations will be optimally placed to exploit new opportunities.
Gillian Lees is a senior innovation manager at CIMA
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David Soskin
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