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 Why is corporate America so dependent on financing.  I can understand if they want to buy a building or build a new factory, but for seasonal or cyclical inventory, payroll or supplies?

  Somebody with CPA instincts or a real one need to explain to me why if is cheaper to not save (and deposit funds in interest-bearing accounts) in favor of borrowing money and paying interest.

  The only explanation I have come up with on my own is that investors and managers are not interested in companies that act prudently, favoring those that act more as just conduits for cash into dividends or, in the case of the latter, salaries and perks.

  Help me out here.  This has got me beat.

Originally posted to Steve Love on Fri Feb 13, 2009 at 08:35 AM PST.

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Comment Preferences

  •  Basic business (1+ / 0-)
    Recommended by:
    notelevision

    Read a few books on business financing. Being prudent also means, let your aggressive competitors eat you alive.

    •  With All Due Respect, I Have Never (2+ / 0-)
      Recommended by:
      oldjohnbrown, iBlue

      worked for a firm with less than 60 folks. We made money. Making payroll, needing a loan, that just makes no sense. Please explain this to me. Please!

      "We are what we repeatedly do. Excellence then, is not an act, but a habit." - Aristotle

      by webranding on Fri Feb 13, 2009 at 08:41:05 AM PST

      [ Parent ]

      •  They keep their cash reserves (2+ / 0-)
        Recommended by:
        oldjohnbrown, crose

        to pay the CEO.

      •  smoke and mirrors (3+ / 0-)
        Recommended by:
        oldjohnbrown, parryander, crose

        Why create a real successful business when the illusion of one will do.

        This whole nation as turned into a house of cards.  All based on sharing a illusion.  Well when home price stopped going up, the illusion had to break.  With it all these other illusions follow.

        Personally as a small businessman, I find it funny that these companies lose billions and somehow still remain in business.  

        Reality is coming back, and the world is gonna crumble before it.

        (regarding the bank mess) They want to cure the patient but not deal with the disease.

        by dark daze on Fri Feb 13, 2009 at 09:11:01 AM PST

        [ Parent ]

      •  ok (0+ / 0-)

        For example, I used to work for a small ISP. The partner that was the finance person insisted that we pay for everything with cash. Our competitor took out loans, bought more modems, became a CLC and eventually the competitor became so big and strong that they bought the small ISP that refused to borrow.
        So, in some situations, a business needs to borrow to beat the competition or at least keep up.

  •  Better to gamble with (3+ / 0-)
    Recommended by:
    Caelian, oldjohnbrown, iBlue

    the other guy's money.

  •  Return on Investment (0+ / 0-)

    As I understand it, the generally accepted economic-psychology goes that money that is not earning the highest rate of return is unproductive investment. For example, if the profit margin in your business results in a 10% return on the dollars you invest into it, then it would be unproductive to park your money in a savings account that earns only 3% on your investment. Ofcourse, this leads to other questions about how much of a risk you take by investing in your business as opposed a safe account. But isn't that risk what is supposed to distinguish the entrepreneurial capitalist from us wage earning sheep?

    •  I hear this. You are on to something here (0+ / 0-)

      but there is another risk, it seems to me, that if I spend my own money and cannot sell my product I still have the company, but if I borrow money and cannot sell my products, the BANK owns my company.

      ...Former candidate for Congress.

      by Steve Love on Fri Feb 13, 2009 at 02:20:44 PM PST

      [ Parent ]

  •  If you ran a business, you'd have known that you (3+ / 0-)

    do not have always cash on hand to either rent something, buy something, pay your workers, get materials, move inventories and so forth. You might have money, but it is not there yet. So instead of hassling and badgering your clients (who are also in the same situation like you), you ask and get a line of credit. All businesses operate like that. Some of those lines are revolving (that is if you have a small business) and some other are not.

    And the bigger you are, the more money you need to keep operating and so forth.

    Hope this helps.

    Don't give a damn a/t each & every politician currently alive in the US. Last time i voted for the top part of the ballot was 1972. Never missed SB election

    by Mutual Assured Destruction on Fri Feb 13, 2009 at 09:01:28 AM PST

    •  this is how (1+ / 0-)
      Recommended by:
      bamabikeguy

      this is how it works now. Doesnt mean its right, and more than likly it will destroy many a company because they simply arent as successful as they act.

      They have been living on borrowed money.

      (regarding the bank mess) They want to cure the patient but not deal with the disease.

      by dark daze on Fri Feb 13, 2009 at 09:08:17 AM PST

      [ Parent ]

      •  The savings by buying supplies in larger lots (0+ / 0-)

        with the intention of turning over the materials as sales, exceeds the amount of interest.

        When I see an adult on a bicycle, I do not despair for the future of the human race. - H.G. Wells

        by bamabikeguy on Fri Feb 13, 2009 at 09:12:57 AM PST

        [ Parent ]

      •  Where I work now... (2+ / 0-)
        Recommended by:
        oldjohnbrown, guyeda

        ...financing is a necessity.

        I work in a college bookstore. I'm only a salesman but I ask a lot of questions and because I'm good at what I do, management takes me seriously enough to answer some of them.

        We have two seasons of major business, semester rush and buyback (at the end of the semester). During buyback, we're handing out huge amounts of cash - sometimes more than the store actually has on hand. But we need to buy the books from students, in part because it's something we're expected to do by everyone, in part because the company can't afford to always buy new books from the publisher, and in part because we want to be able to sell used books (which are cheaper and promote higher volume of sales). So what do we do? We go to the bank and get a loan, arranged from corporate headquarters.

        During the first few weeks of the next semester, though, we're typically pretty deeply into the black. So the loan can be repaid.

        That's just an example, and somewhat oversimplified.

        Ask not any question of the Eldar; for they will give you three answers, all of which are true, and all terrifying to know.

        by Shaviv on Fri Feb 13, 2009 at 09:17:34 AM PST

        [ Parent ]

        •  and again (1+ / 0-)
          Recommended by:
          oldjohnbrown

          that is basic simple credit.  The leveraging that goes on in the US and wall street is an entirely different and insane creature.

          (regarding the bank mess) They want to cure the patient but not deal with the disease.

          by dark daze on Fri Feb 13, 2009 at 09:22:02 AM PST

          [ Parent ]

        •  I'm familiar with the sales part of this (0+ / 0-)

          sometimes more than the store actually has on hand.

          operation.  I worked for a university bookstore my junior year and can see what you are saying.  But that does not ask the why.  The managers know this seasonal cycle...just like farmers know they need to buy seed in the Spring...but why, over time, do they not have money ratholed so they can self-finance for the run on their cash reserves and save the interest costs of borrowing?  That's what I am trying to understand?

          ...Former candidate for Congress.

          by Steve Love on Fri Feb 13, 2009 at 01:37:11 PM PST

          [ Parent ]

      •  My father had a small business in the 1950s (1+ / 0-)
        Recommended by:
        oldjohnbrown

        and 1960s and he operated this way. He had a small line of credit from a local neighborhood bank to pay his workers because he hated to pay them late.

        And he paid off that line of credit almost every month.

        I think for small business it is still the same thing, unless i am way out of touch...

        Don't give a damn a/t each & every politician currently alive in the US. Last time i voted for the top part of the ballot was 1972. Never missed SB election

        by Mutual Assured Destruction on Fri Feb 13, 2009 at 09:22:19 AM PST

        [ Parent ]

        •  yep (1+ / 0-)
          Recommended by:
          Mutual Assured Destruction

          big business is entirely different. Especially fiancial instututions.  Leveraged out the ying yang.

          (regarding the bank mess) They want to cure the patient but not deal with the disease.

          by dark daze on Fri Feb 13, 2009 at 09:24:23 AM PST

          [ Parent ]

          •  I am well aware of leveraging of financial (3+ / 0-)
            Recommended by:
            Shirl In Idaho, Steve Love, Conure

            institutions and how they operate.

            But, i don't think of financial institutions are businesses. Never thought of them as one actually. I don't know why.

            Whoever buys a mortgage then another one, then packages it together and sells it to an institution and then that institutions gets a credit line that leverages 10 times the value of those mortgages to again go back in the market and buy more mortgages, to me, is not producing anything. Thus, it is not a business.

            PS: I was reading a small article on FT last night that says that the mortgages of a small town on the coast of Florida were leveraged about 31 times. That means if you bought a house that is worth $1000, the guy who bought that mortgage sold it for $31000. And some banks in Europe bought that package.

            Don't give a damn a/t each & every politician currently alive in the US. Last time i voted for the top part of the ballot was 1972. Never missed SB election

            by Mutual Assured Destruction on Fri Feb 13, 2009 at 09:33:15 AM PST

            [ Parent ]

    •  Its the supply chain-i.e. drapes (2+ / 0-)
      Recommended by:
      oldjohnbrown, notelevision

      the fabric supplier makes large lot purchases from a mill, but then sells the rolls in smaller units to sewing rooms, but transfers the account to a factor (or holding bank, because he "charged" the initial huge purchase).

      The sewing room then makes the spec drapes to a wholesaler, a retail units.

      All along the line are terms of payments, 30-60-90 days.

      Along the way, small parts of the supply chain get a big contract, have to expand rapidly, hire immediately, retool instantly.  Credit is how it happens.

      When I see an adult on a bicycle, I do not despair for the future of the human race. - H.G. Wells

      by bamabikeguy on Fri Feb 13, 2009 at 09:10:55 AM PST

      [ Parent ]

      •  thats how (0+ / 0-)

        thats how credit used to work.  Now its totally out of control.

        (regarding the bank mess) They want to cure the patient but not deal with the disease.

        by dark daze on Fri Feb 13, 2009 at 09:14:39 AM PST

        [ Parent ]

        •  What are you thinking of? (0+ / 0-)

          I mean, what business are running entirely off loans with the intention that it should be so, as opposed to unhappily in debt, or using the odd loan here or there to supplement their cash?

          Ask not any question of the Eldar; for they will give you three answers, all of which are true, and all terrifying to know.

          by Shaviv on Fri Feb 13, 2009 at 09:19:44 AM PST

          [ Parent ]

          •  large american businesses (0+ / 0-)

            large american businesses and financials are leveraged out the ass.  The ratios are INSANE

            (regarding the bank mess) They want to cure the patient but not deal with the disease.

            by dark daze on Fri Feb 13, 2009 at 09:25:42 AM PST

            [ Parent ]

            •  Tell me more. (0+ / 0-)

              Or at least, suggested reading...

              For serious, you're talking to someone whose only business experience is working in a small and neglected branch of a large "absentee parent" company. I understand what leverage ratio means and why normal people would think lower is better. Why would anyone think higher is better, and push for more? What are the causes of high leverage ratios, other than a debt spiral that indicates a company is going under?

              Ask not any question of the Eldar; for they will give you three answers, all of which are true, and all terrifying to know.

              by Shaviv on Fri Feb 13, 2009 at 09:37:27 AM PST

              [ Parent ]

          •  My question has its genesis in the chatter I (0+ / 0-)

            hear that "credit is not flowing" that banks are not lending to credit-worthy borrowers.  Well, why are they not lending, but the other question that occurs to me is has to do why the so-called credit-worthy borrowers NEED to borrow.  Do these yahoos just wake up to a new world every morning and have no clue as to the profile of their cash flow over time?   It would seem to me that Econ 101, lesson one, is that borrowing costs more than cash.  Were these guys standing behind the door when that lesson was studied?

            ...Former candidate for Congress.

            by Steve Love on Fri Feb 13, 2009 at 01:45:29 PM PST

            [ Parent ]

            •  "Credit-worthy" is not the same (0+ / 0-)

              as "sitting on piles of cash". A person or organization might be credit-worthy if they have a reliable cash-in flow, or if they have always paid their debts promptly, regardless of how much cash is on hand right now; and as for what circumstances would require a person or organization to come up with the money right-now-can't-wait, you can pick a hundred or more, many relating to sudden and unforeseen consequences and insurers that weasel out of their obligations.

              Ask not any question of the Eldar; for they will give you three answers, all of which are true, and all terrifying to know.

              by Shaviv on Fri Feb 13, 2009 at 01:57:30 PM PST

              [ Parent ]

    •  I understand how that might be necessary in the (0+ / 0-)

      So instead of hassling and badgering your clients (who are also in the same situation like you), you ask and get a line of credit.

      beginning of an enterprise but it seems to me, that after 5 years or so, if there was a will, a company could rat-hole funds to not have to borrow any more for what is, in effect, walking around money.  What am I missing?

      ...Former candidate for Congress.

      by Steve Love on Fri Feb 13, 2009 at 01:28:22 PM PST

      [ Parent ]

  •  Comes down to cash flow? (0+ / 0-)

    I had a small business and that was always the problem while getting established. Making sure I had enough to cover everything.

    I really don't understand how bipartisanship is ever going to work when one of the parties is insane. - John Cole

    by Gorette on Fri Feb 13, 2009 at 09:20:15 AM PST

  •  hostile takeover (3+ / 0-)
    Recommended by:
    Caelian, oldjohnbrown, EthrDemon

    Of course it would be prudent (and cost less) for businesses to maintain their own reserves.  But . . . the system is structured to encourage borrowing rather than the retention of capital, because that's how the money lenders make their money. So the whole tax structure is skewed to favor "money management" that favors the lenders (a small, concentrated group that has a lot of political power) over owners (a larger and more dispersed group that is more difficult to organize politically).

    Borrowing is further encouraged because a business with large cash reserves produces a short term paper gain for "raiders" if they buy the business, liquidate (distribute) those reserves, take on debt for the business, and then sell and move on (leaving behind the indebted shell of the business just looted).

  •  venture capital (2+ / 0-)
    Recommended by:
    Caelian, parryander

    It's about getting other people's assets earning money for you.

    Is the money that you would have earned as interest greater than the money that you will earn in profits on sales of the inventory that you bought?   If not, then it is not "cheaper" to put the money in the bank.

    One good example is purchasing real estate and renting it out.  You borrow money from someone, buy a duplex, rent it out, and then have your renters pay your mortgage, and also pay you a little extra money, as well.  It is not practical for someone to do this with their own money.   Most of us just don't have $100,000 or more laying around.  But, credit allows us to leverage the investor's funds, and we make far more money in equity and income than we would with the money sitting in the bank earning 2% interest.   The investor is OK with it, too, because he is earning interest on his investment.  All of us earn more than than we would with our money sitting in the bank -- unless we invest unwisely, and our property values fall by 50%, but that's another discussion about risk vs. return.

  •  My business is an (1+ / 0-)
    Recommended by:
    notelevision

    exception - I work with cash on hand. Of course, I have no employees, and take very few risks. I have no debt, but also struggle to stay afloat.
    When I have a large purchase to make I get my clients to put up 1/3. I'm a landscaper, by the way.

    "Junkies find veins in their toes when the ones in their arms and legs collapse." - Al Gore

    by parryander on Fri Feb 13, 2009 at 09:31:38 AM PST

    •  Landscaping (1+ / 0-)
      Recommended by:
      parryander

      and other such service businesses are very typically managed just that way--few employees, few risks, debt paid off with seasonal earnings. My favorite greenhouse/nursery is a family-owned place that employs four people in winter and up to twelve in summer. I know that they have to take out a loan now and again for big tree stock, but they make it back pretty quickly. They work their asses off though, and I don't think they can retire, even if they wanted to.

      Before you criticize someone, you should walk a mile in their shoes. That way, when you criticize them, you're a mile away and you have their shoes.

      by crose on Fri Feb 13, 2009 at 09:38:15 AM PST

      [ Parent ]

      •  yes (0+ / 0-)

        small earnings, but lots of risk in crop failures, seasonal whims. I frequent several small family wholesale nurseries( to spread my little business around) and every year has been tougher and tougher for them.

        "Junkies find veins in their toes when the ones in their arms and legs collapse." - Al Gore

        by parryander on Fri Feb 13, 2009 at 11:10:43 AM PST

        [ Parent ]

  •  future value and opportunity cost (0+ / 0-)

    If your money sits in the bank and accrues for 5 years until you have enough to do what you want to do, will the interest that you have earned be more than you would have earned if you had borrowed the money, paid the interest, and conducted business and earned profits over those same five years.  There is a business concept of "future value", where you calculate what your money will be worth in five years, and another business concept of "opportunity cost" which talks about the cost of NOT doing something.  How much does it cost you to NOT purchase that extra inventory and sell it during Hot Friday, and leave your money sitting in the bank earning interest, instead.

    Money sitting in the bank is relatively low risk and safe, and therefore, it is not very profitable.  When people take more risks, they have a chance to earn more, but they also have a chance to lose more.

  •  Joe Nocera's lucid article... (0+ / 0-)

    ...in the New York Times Sunday Magazine a month and a half ago has some good answers and analysis.  It's a fundamental dynamic of fiduciary duty and profit maximization.  The essay was entitled "Risk" and examined in detail the 'Value At Risk' formula from which so much of current loss has stemmed.

    Welcome to capitalism.  What should we do about it?

    I bow to those who seek the truth; I flee from those who have 'found' it.

    by SERMCAP on Fri Feb 13, 2009 at 10:18:54 AM PST

  •  some companies are prudent and well-run (0+ / 0-)

    for example, huge companies like Microsoft or Apple has 16 Billion cash reserve. They never have to borrow. Smaller companies too. Of course, using your own money always have zero interest and ideally, that is what every body want.

    However, some (or many) not so profitable companies have to borrow to survive and payback when they have money, which is the case you posted. They do not have enough money to do expansion, simple as that. They do not have a reserve.
    So they have to borrow to meet their need (expansion or payroll).

    Hope that help.

    •  It does. What I am hearing is that secure (0+ / 0-)

      companies like Microsoft, indeed, self-finance because they are successful enough, as reflected, precisely, by their cash reserves, to do exactly that...and then there is the rest of the business world that operates with one foot on a banana peal...aka NO or little cash reserves...that have to have regular cash infusions to stay afloat.  Did I get you right?

        Question: Could this lack of cash reserves reflect not just the tenuous nature of their business but management's decision to chose CEO bonuses, dividend distributions, stock buy-backs, etc. rather than saving cash?

      ...Former candidate for Congress.

      by Steve Love on Fri Feb 13, 2009 at 02:01:43 PM PST

      [ Parent ]

      •  it really depends on the leadership (0+ / 0-)

        Could this lack of cash reserves reflect not just the tenuous nature of their business but management's decision to chose CEO bonuses, dividend distributions, stock buy-backs, etc. rather than saving cash?

        Successful companies can do both: reserve + adequate compensation. Microsoft is obviously one example but there are many. The answer is adequate and fair: if the company makes $10, they use $3 for bonus and $7 for saving. Whereas what you say could be that companies make $10, they borrow $2 more for $12 for bonus! That is.

        It really depends on the leadership. Often, if the company is own/created by owners, they tend to follow what you say. But several/many companies are now hiring outside CEOs with little bond with the company and those bastards just milk the companies and rewarded themselves as much as they can.

  •  Depends on the business (1+ / 0-)
    Recommended by:
    Brian B

    Large corporations use this as a function of their cash management. Up until not too long ago companies could float millions in temporary borrowings through the commercial paper markets at a quarter or half percent interest and this would be unsecured debt as well. It keeps them from getting caught short where the temporary lack of funds could cost them opportunities.

    For small businesses this is usually accomplished through lines of credit or through credit cards as they wouldn't be borrowing enough to get into the paper markets. But largely it is for the same reason to smooth out cash flows and prevent the situation where they have bills coming due on Thursday the 1st and the biggest sales day of the week is Friday the 2nd - they would get caught short and perhaps miss a payment or have to take other action.

    In theory it should never be a great cause for concern. In fact, it was one of the more non eventful aspects of the economy.

    However, what happened in the commercial paper markets was that financial companies were floating paper to cover there shortfall on long term debt and they were falling further and further behind on it. The size of their borrowings increased. Which led to requirements for collateralization. This led to companies like WAMU and Bear Sterns and the like to use the flow of mortgage payments from mortgage bundles as collateral even though these mortgage bundles were experiencing defaults left and right.

    And the spiral began. It forced non financial firms to pay more interest on their paper. It required some of these same non-financial corporations to put up collateral where they hadn't been required to do so in the past. With much of their plant and equipment already pledged to long-term financing it became impossible for some to use the paper market.

    It forced those companies to turn to their lines of credit - which the banks issued expecting that they would be used infrequently and thus there wasn't money behind these lines of credit in the bank but they had a contractual obligation to provide which required the banks to have to go out and borrow that money.

    So for all of the trouble in the commercial paper and business lines of credit it can all - and I do mean all - be traced back to these CDO and RMBS products and more pointedly to the 2005-2007 vintage bundles. It was nothing short of a Ponzi scheme run by racketeers that should be arrested and tried under the RICO statutes.

    •  This is much more than I was asking for (1+ / 0-)
      Recommended by:
      Brian B

      commercial paper markets at a quarter or half percent interest and this would be unsecured debt as well.

       but is MOST HELPFUL as it fills in some holes and confirms some of my speculations.  
        This paper market.  I had no idea that credit could cost so little. 1/4 to 1/2%...makes my credit card rate look like highway robbery...WHICH IT IS.
       It makes sense that companies with access to such funding would prefer to spend now and forgo savings if they can get OPM at that rate.  Hell, I'm for the other guy taking all the risk, too.  :-)

        BTW: If you ever need some rope for these guys who hatched this scheme, let me know!!!

      ...Former candidate for Congress.

      by Steve Love on Fri Feb 13, 2009 at 02:12:47 PM PST

      [ Parent ]

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