There are two ways to raise money to run your business: equity and debt. You can sell ownership in your business by issuing stock. The stock purchaser is an owner of your business. On the other hand, you can issue debt. The other party is a creditor- not an owner. Now, finance has become pretty complex over the years. But the stock or debt decision still remains.
A professor I had described a banker as someone who checks the floor on all fours sides of the bed before getting up in the morning(!) It’s a nice visual that refers to the fact that bankers should be cautious people. After all, they are lending someone else’s money- not their own.
Commercial bankers are those that lend to businesses. They want to make sure that the company/ borrower has sufficient earnings to pay the interest on the loan, as well as the principal. So, your firm needs to have some “room” in your income statement. If your company takes out a loan, it wil have an additional expense for interest. There’s also a cash flow issue: the company needs enough excess cash to make interest and principal payments over the life of the loan.
Now, a company borrows money for a specific purpose. The goal is that the rate of return (profit) generated by the loan will more than cover the interest expense. If you borrow money for a new machine, maybe you can produce more product than the old one. If you produce and sell more product, your earnings can increase. If the increase in earnings is more than the interest expense of the loan, you’re financially better off.
Consider your cash flow. If you produce and sell more product, you’ll collect more cash. If the addition cash you collect is more than the principal and interest cash payments, you have more cash.
Ideally, our cautious banker would love a company that doesn’t have much existing debt- which means they don’t need much extra earnings (or extra cash) to make interest and principal payments. The banker would love a company with increasing revenue and earnings.
Which brings us to Apple Computer.
A recent Wall Street Journal article (“Apple's Record Plunge Into Debt Pool”, 5/1/13) explains the huge public interest in buying Apple’s recent debt offering. In fact, the article explains the “$17 billion offering investors hungrily gobbled up”. It was Apple’s first bond offering in 20 years.
“The technology company as able to borrow at rates nearly as low as the highest triple-A rated firms in the world”. Triple-A is the highest rating issued to companies that borrow money. A very small percentage of companies have a triple-A credit rating.
Bond rating companies give Apple a AA+ rating, based on “excellent liquidity and significant net cash balances”. In other words, Apple has a large number of assets that they could sell for cash- or convert to cash quickly (liquidity). Those assets include current assets, like accounts receivable. Apple also has huge cash balances. In fact, they issued the debt to finance cash needs in the U.S. Much of Apples cash is overseas. Apple issued the debt, in part, to avoid taxation on needed cash they might move from overseas.
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