Debt in the firms balance sheets Essay Example | Topics and Well Written Essays - 1750 words

Debt in the firms balance sheets - Essay Example The paper presents ordinary shares that can be simply defined as shares which are not preferred shares and which do not offer fixed dividend amounts. As Nevin states, an ordinary share directly indicates equity ownership in a company and it entitles the owner to voting rights in various crucial affairs of the company in proportion to their percentage of shareholding. Ordinary shareholders are entitled to receive dividends on their investment only if anything left after all liabilities are paid. In contrast, debt is an obligation owed by one party (debtor) to another party (creditor). In case of debts, lenders have no rights on the firm’s operations and are unable to take part in determining major strategic issues. Organisations and businesses across the world use debt to finance their day to day operations and other particular projects. The levels of debt are fundamental macroeconomic data and it they largely vary from company to company. Generally, levels and flows of public debt are given central importance while levels and flows of private debt are not considered as a major cause of concern. Stocks and flows are two important tools of debt measuring. Stocks are levels of debt and they have units of currency whereas flows change in debt levels and have units of currency/time. All credit is debt and it is created by lenders who agree to lend money for the exchange of adequate future returns. Lundgren reflects that the amount of money lent is considered to be the asset of the creditor while it becomes the liability of the debtor. Debt is often issued along with a specific repayment plan; and the debt maturity time or period of repayment may range from a few days to 50 years or longer. According to the maturity period, debt is classified into three categories such as short term, medium term, and long term debt. In order to accurately calculate total debt of a business, it is necessary to take off-balance sheet debt into account as all debt items may not s how up on the balance sheet. As Shearn (2011, p. 116) states, these debt items may include lease obligations, warranties, purchase contracts, unfunded pension liabilities and any other contractual obligation. However, this type of debt is generally disclosed in the footnotes attached to the financial statements. White, Sondhi & Fried (2006, p. 323) indicates that the liability amount shown on the balance sheet may not always represent total cash flow required to meet the debt. Business houses only record the present value of the future cash flow. To illustrate, if a firm borrows $1,000 at an interest rate of 12%, total amount payable at the end of that period becomes $1,120. However, the balance sheet will only represent the present value of the future payment or $1,000. Factors affecting levels of debt As Crane, Knoop, and Pettigrew (1977) point out, different firms have varying strategies in maintaining their debt levels and this strategic differences cause debt level variances in firms’ balance sheets. A firm considers an array of factors before framing its debt level strategies. In the words of Long and Ravenscraft (1993), no firm would allow its debt level to grow beyond its repayment capacity as this condition may adversely affect the feasibility and market repute of the business. More precisely, a firm’s debt level heavily depends on its borrowing policies. â€Å"Tthe capacity to borrow depends on several factors such as profitability, stability, relative size, asset competition, and the industry position of a business† (Shearn, 2011, p.115). Hart (1995, p. 142) argues that profitability plays a pivotal role in determining the debt level of a business house. General trends indicate that level of debt will be in an