Dictionary / How companies make money
What Does Debt Mean for a Company?
Debt is money a company has borrowed and must pay back, usually with interest. Used well, it helps a company grow. Too much of it can sink a company in hard times.
Why companies borrow
Borrowing lets a company build a factory or buy a rival today instead of saving up for years. If the new project earns more than the interest costs, owners come out ahead.
When debt becomes a problem
Interest must be paid in good years and bad. If revenue drops, the payments stay the same. A company with too much debt can run out of cash, cut its dividend, or even go bankrupt. Shareholders are paid last, after lenders.
How to tell if debt is too high
- Compare debt with yearly EBITDA. Many investors get careful above 3 to 4 times.
- Check if free cash flow easily covers the interest.
- Compare with similar companies. Utilities and telecoms usually carry more debt than software companies.
Debt changes what a company is really worth
Two companies with the same market cap are not equal if one has much more debt. Enterprise value adds debt in, so you can compare them fairly.
See it in real companies
Open a company to see what it sells and how it makes money.