====== Corporate Debt ======
Corporate Debt is, quite simply, money that a company borrows. Think of it like a mortgage on a house or a car loan, but for a business. Companies raise this money from various sources, most commonly through `[[Bank Loan]]`s from financial institutions or by issuing `[[Corporate Bond]]`s directly to investors. This borrowed capital is not free; the company must pay it back over an agreed period, along with `[[interest rates]]` as the "rent" for using the money. For investors, understanding a company's debt is non-negotiable. It's a fundamental part of the capital structure that can either fuel spectacular growth or sink a company into `[[bankruptcy]]`. A savvy `[[value investor]]` doesn't just look at a company's profits; they look at its obligations. Debt is a powerful tool, but like any tool, it can be dangerous in the wrong hands or if used excessively.
===== The Two Flavors of Corporate Debt =====
While companies can borrow in many ways, most corporate debt falls into two main categories: bank loans and bonds. Each has its own characteristics and implications for the business and its investors.
==== Bank Loans ====
This is the classic form of borrowing. A company goes to a bank or a syndicate of banks and takes out a loan, much like an individual would.
  * **Structure:** These loans often have variable interest rates tied to a benchmark rate like LIBOR or SOFR.
  * **Security:** They are frequently secured loans, meaning the company pledges specific `[[assets]]` (like inventory, buildings, or equipment) as collateral. If the company defaults, the bank can seize those assets.
  * **Covenants:** Loans almost always come with `[[debt covenants]]`—strict rules the company must follow, such as maintaining certain financial ratios. Breaking a covenant can trigger a default.
==== Corporate Bonds ====
When a large, established company needs to borrow, it can bypass banks and go straight to the public capital markets. It does this by issuing bonds, which are essentially I.O.U.s sold to a wide range of investors.
  * **Structure:** Bonds typically pay a fixed interest rate (called a `[[coupon rate]]`) to bondholders, usually semi-annually, and return the principal amount on a specific `[[maturity date]]`.
  * **Tradability:** Unlike a private bank loan, bonds are securities that can be bought and sold on the open market.
  * **Ratings:** Bonds are rated by agencies like Moody's and S&P Global Ratings based on the company's perceived ability to repay its debt. These `[[credit ratings]]` (from AAA down to "junk" status) heavily influence the interest rate the company must offer.
===== Why Do Companies Take on Debt? =====
Debt isn't inherently evil. When used wisely, it's a critical engine for growth and value creation. The main advantage is that debt is usually a cheaper source of financing than `[[equity]]`. This is because interest payments are tax-deductible, and lenders have a stronger claim on a company's assets than shareholders, making it less risky for them. This strategic use of debt to amplify returns is known as `[[leverage]]`.
Common reasons for taking on debt include:
  * **Funding Growth:** Financing major projects like building a new factory or expanding into a new market (`[[Capital Expenditure]]`).
  * **Acquisitions:** Borrowing money to buy another company (`[[Mergers & Acquisitions]]`).
  * **Managing Capital Structure:** Issuing debt to finance `[[Share Buybacks]]` or pay `[[dividends]]`, thereby returning capital to shareholders.
  * **Day-to-Day Operations:** Covering short-term expenses and managing `[[working capital]]`.
  * **Refinancing:** Paying off old, more expensive debt with new, cheaper debt.
===== A Value Investor's View on Debt =====
For a value investor, analyzing a company's balance sheet—especially its debt—is where the real detective work begins. While debt can supercharge returns in good times, it can be an anchor that drags a company down in bad times. A company with low or no debt has a much larger margin of safety to survive recessions or industry downturns.
==== The Red Flags ====
Excessive debt is one of the biggest red flags. A company that is too heavily leveraged has very little room for error. A small dip in revenue can quickly become a crisis if the company can't make its interest payments. This is how seemingly healthy companies can spiral into financial distress. Therefore, a prudent investor always scrutinizes the //amount// of debt and the company's //ability to service it//.
==== Key Metrics to Watch ====
To move beyond gut feelings, investors use several key ratios to assess a company's debt load.
=== Debt-to-Equity Ratio ===
This classic ratio compares a company's total liabilities to its shareholders' equity.
  - **Formula:** Total Liabilities / Shareholders' Equity
  - **What it tells you:** It shows how much the company is relying on borrowing versus its own funds. A ratio of 1.0 means the company is financed by equal parts debt and equity. A high ratio (say, over 2.0) can indicate high risk, but context is king—capital-intensive industries like utilities or manufacturing naturally have higher ratios than software companies.
=== Interest Coverage Ratio ===
This ratio measures a company's ability to make its interest payments from its profits.
  - **Formula:** `[[EBIT]]` / Interest Expense
  - **What it tells you:** It's a direct measure of solvency. A ratio of 5x means a company's operating profit is five times greater than its interest expense. Investors typically look for a ratio of at least 3x, and the higher, the better. A ratio below 1.5 is a serious warning sign.
=== Net Debt-to-EBITDA ===
A favorite metric of many professional investors, including `[[Warren Buffett]]`, this ratio shows how many years it would take for a company to pay back all its debt using its earnings. It's considered superior to Debt-to-Equity because it uses `[[Net Debt]]` (total debt minus `[[Cash and Cash Equivalents]])` and focuses on cash flow (`[[EBITDA]]`) rather than accounting-based book value.
  - **Formula:** (`[[Short-Term Debt]]` + `[[Long-Term Debt]]` - Cash) / EBITDA
  - **What it tells you:** A ratio below 3x is generally considered healthy. A ratio above 4x or 5x suggests the company is heavily indebted and may face financial difficulties, especially if its earnings are volatile.