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Why You Need Debt To Grow

Managers of small companies sometimes wonder why a successful company with an unbroken record of profits is short of cash. But, in fact, growth in sales increases the need for financing. A small company with, say, $100,000 in assets ($60,000 in current assets and $40,000 in fixed assets) that is financed by $30,000 current liabilities and $70,000 of owner's equity usually needs more assets to expand its operations and, through such expansion, increase its sales.

Let's assume that this company wants to double its sales. To support that increase, let's further assume that assets have to be increased to $150,000. If current liabilities could be expanded by $20,000 then $30,000 must be found. The two main sources for this $30,000 are reinvested earnings and debt. If the income realized by the firm after taxes is $10,000, and the owner decides to reinvest it completely, there is still a need for $20,000.

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Last updated: Nov 1, 1981




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