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Why is Credit Extended to Companies and How Do They Make Their Payments?

Name: Hemant Damle
City & State: Tucson, Ariz.

Question/Comment: Can you explain the how and why of credit that is extended to companies and how they make their payments? I understand credit to start new ventures, buy new equipment, hire a workforce, and the like but how do companies that have been in business for dozens of years still need access to credit to grow and survive? Don't they save money like the rest of us do to buy vehicles, pay for college, etc. and pay as they go? Isn't that part of what profits are for? And why are their payments so gargantuan and spaced out in time? Don't they make monthly payments like the rest of us? I mean, how does the New York Times Co. wind up owing $400 million? It doesn't make sense.

Paul Solman: Most companies feel they need to grow. Growth costs money -- in the Gray Lady's case, for more reporters, new bureaus, a new section of the newspaper, the New York Times online, etc.

Money can come from shareholders, buying newly issued stock in the company, or it can be borrowed, the more usual route for established firms. The cost of borrowing -- the interest -- will supposedly be paid from added growth, or savings the company will supposedly achieve by operating more efficiently. (This efficiency dream is wishfully called "the discipline of debt.")

The problem isn't how much you borrow, it's what you do with the money. If you invest in something people will want that will pay more than what you paid to create it (including the payments for the loan you take out), then you can borrow every penny.

The simple reason is that you'll earn more than it cost you to borrow. Invest in something that WON'T cover the cost of financing it and you've got General Motors, Circuit City, America's banking system, Iceland and, it would seem, my favorite newspaper in the world, The New York Times.

-- Posted February 4, 2009 | Comments ( ) | Permalink