How The Risk Of Bankruptcy Represents A Disadvantage To Using Debt?

Week 4 Name Institution Week 4 How the risk of bankruptcy represents a disadvantage to using debt A company which uses debt to run the business stands a high chance of being bankrupt. This makes it hard for a company to be able to meet its financial obligations to creditors. Thomas A. Durkin observes that ‘debt levels as a leading cause of bankruptcy filings CITATION Tho14 \l 1033 (Durkin, Elliehausen, Staten, & Zywicki, 2014). This shows prevalence of debts is mainly attributable to debt levels. Bankruptcy comes with costs which vary for different firms such as losses incurred from selling assets at low prices and increased borrowing costs due to poor credit. Using debt as part of the capital structure of a company increases these costs and eventually leads to the destruction of a company’s reputation. It also destroys the brand equity of a company. In the end, a company loses market share and competitive positioning. Factors to consider when determining the capital structure of a given company * Trading on equity. Equity is the value of shares issued by a company. Trading on equity is the use of equity share capital shares to borrow funds on a reasonable basis. Equity shareholders earn additional profits when they issue debentures and preference shares. Trading on equity becomes significant when the shareholders’ expectations are high. * Market conditions. The market price of shares in a company has a significant influence on a company’s capital structure. When there are unstable market conditions, the interest rates to borrow may be high, thus a company might be unable to pay. Such a situation makes a company to practically wait till the market conditions are stable to access funds. * Management style. The management style of a company, conservative and aggressive, determines the capital structure of a company. A conservative management style rarely uses debt to increase profits whereas an aggressive management can use debt to increase its profits since it wants the firm to grow quickly. Aggressive management leverage their working capital highly and often they lead to their businesses into bankruptcy CITATION Eli11 \l 1033 (Talmor & Vasvari, 2011). * Stability of sales. A company is in a position to meet its obligations when it has a growing market and a high sales turnover. The interest on debentures is p...