When is debt too much?
Stanislav (Stan) Sukhinin, CFA
Help business owners of $3M–$35M revenue optimize cash flow and achieve business goals | Fractional CFO w 18y of experience | AI Super User according to Washington Post
Determining the optimal capital structure of debt/equity is an essential question for almost every CFO around the world
The theory states that there is always a trade-off between tax savings (or tax shield) and financial risk
If a company has too much debt, the financial risk becomes so high that the interest rate a lender charges such a company is way higher than the return on capital
As a company crosses this critical point, it begins to destroy shareholder value because it starts paying debtholders more than equity holders
So, when is debt too much? When ROC (return on capital) < COC (cost of capital), it means that the company is overburdened with debt