Financial Debt Management

Financial debt: definition and issues

Financial debts are the borrowing resources that a company uses, alongside the financing it receives from its equity, to finance both its operating cycle and its investment cycle. Companies often resort to debt when they do not have sufficient available capital or to use it as a financial management tool. It is both a means of development through the possibilities it offers (investment, working capital financing, innovation, …) and a danger for companies that fail to control their debt ratio. This is why it is essential for companies to be attentive to their indebtedness in order to manage it better. How to achieve this? That is the question that the following lines will answer.

Managing financial debt

Managing financial debt involves establishing a strategy to mobilise a number of actions and put in place a number of precautions to avoid falling into the risks of non-repayment of debt. The aim of debt management is to reduce exposure to interest rate risk, because whether at a fixed or variable rate, any borrower is exposed to interest rate fluctuations, which results in gains or losses of opportunities. Managing this risk requires an appropriate distribution of the different types of indexation used by the company.

Key factors to control

Regardless of the type of debt contracted (bonds, bank loans, etc.), controlling several factors such as maturity, interest rate, possible arbitrage, and early repayments, are essential to debt management, if one wishes to minimise the risk of non-payment or late payment. Indeed, poorly structured debt, whether in terms of maturities, interest rates, or the existence of high liabilities, predisposes the company to easily fall into the risks of poor debt management, payment negligence, and thus non-repayment.

The risks of a complex portfolio

A complex financial debt portfolio can often place a substantial risk on the company's balance sheet and financial stability. Problems in managing financial debt often arise from the fact that decision-makers do not pay sufficient attention to the fact that it is profitable to manage debt prudently, costly to mismanage it, and thus accumulate high indebtedness, accompanied by a poor banking history (regarding debt payments) attached to their company.

Precautions for good debt management

Thus, to manage its debt well, the indebted company will need to take a number of precautions:

• set clear objectives for debt management (amount to pay each month, total amount to repay, debt maturity…)
• limit the expansion of debt (not allowing itself payment delays)
• manage interest charges prudently (does the interest rate change if a payment is missed?, does the interest rate change if payments are made more quickly than planned?...)

A strategic decision

Debt is particularly useful when the company does not have sufficient equity available or when debt provides a more economical way to finance projects. It is therefore not a decision to be taken lightly or on a whim; but after analysing the situation of its company (profitable, solvent) and its ability to meet the repayment required by the debt; and this while respecting the required deadline.