There are various symptoms that may indicate a firm having strategic problems. One symptom may be having too much debt. One of the easiest way to see if a company is struggling is by looking at there liability. If a company has too much debt, they would have a problem with their working capitals. With an insufficient asset, when in time of downturn economy, paying off the creditors will be a tough task. Too much debt will also prevent the company from expanding and turn off potential investors.
Another symptom could be a company slow to introduce new products in a fast changing environment. This holds true for a lot of technology companies. If a company can’t keep pace with its competitor, they will surely lose their share of the market. That’s why a company shouldn’t just sit back when they have a competitive advantage. A company should preach innovation and growth because in today’s world nothing is static.
Two companies that have been incurring too much debt are Fannie Mae and Freddie Mac. During the subprime mortgage crisis both of these two companies took on a large amount of housing debts. They maintain a capital that is very small compare to their debt obligation. Now there is a chance both of these two companies could default and requiring government bail out. One of the reasons why they took the risk is because they felt the government will support them if they default and the worst case scenario may occur now. Freddie Mac reported their first ever lose during 2007 and Fannie Mae reported their first ever in 22 years. Could they be in a debt that is to deep to get out of?
2 comments:
I agree with your assessment of debt is a sign of vulnerability for a firm. But could be that they need to debt for its research and development and is a necessity within the industry to compete with their competitors. A start up like you mentioned (technology) is a example they need the fund to grow but as a investor you know that going into the company so you are aware of the situation. With due diligence one should not always skeptical on the a firm with high debt.
Good job Hao.
In response to the previous comment, I think I can help Hao future explain his point since we wrote about the same topic on too much debt. I do agree with Adnan’s comment that we shouldn’t be skeptical on a company with too much debt, because of reasons such as funds needed for R&D to remain competitive within the industry. I believe what Hao was trying to get at is that too much becomes a strategic problem only when the company is unable to meet its obligations. Like I mentioned in my entry, when the amount of debt goes out of hand, the company might result in bankruptcy. Do you agree with my explanation, Hao?
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