Taking on debt isn't necessarily value-destructive, otherwise companies would prefer to run debt-free.
As any corporate finance book will teach you, increasing leverage simply means returns to equity holders are more volatile.
It's like adding debt to a lemonade stand that generates $1 a day everyday for the chance of instead generating $5 or ($5) everyday.
People (managers, investors..) have varying appetites for risk, but at the end of the day, these are all consenting adults and they can do as they please within the limits of the law.
Even if they are net debt free, they often run a line of credit to even out the bumps between when money is received and when it must be disbursed (such as for payroll).
No, they don't, unless they're small companies who are very risk-averse perhaps. I'd wager there isn't a single debt-free company in the Russell 2000 index.
That's restricting the definition of company a lot. (Note that I'm not saying that most companies run debt-free, just that it's a somewhat significant percentage, almost certainly double-digit. Probably mostly smallish companies indeed. Mostly single-owner or family-owned I guess. And, as a nearby comment said, almost all will take on temporary debt to smooth operations when needed. I worked for one with about 80 employees, but not in the financial department.)
If that was the primary reason for a company to take on debt, wouldn't it be preferable to instead run the company debt-free and let the equity holders leverage themselves to their desired risk level by taking on debt themselves?
That's a valid question, but at least two reasons come to mind which would explain why investors leverage the company instead.
Taxes are paid after interest, so leverage effectively creates a "tax shield" that can be very advantageous.
Even if that weren't the case, equity holders have limited liability. They are only liable up to the amount they invested. Naturally, their incentives are usually aligned with that of lenders, since nobody is better off in the event the company goes under.
But very risk-tolerant investors indeed take on leverage themselves, often in the form of what is called margin trading. It can bring outsized returns, but those investors are also potentially liable for more than they invested.
I know what you're saying, but I think it's easier to conceptualize if you write the equation:
Assets = Liabilities + Equity
The other way lends credence to the thought that an increase in liabilities requires a decrease in equity. Without knowing how journaling works, I think such an error would actually be quite logical.
What would you think of a person who confidently made erroneous assertions about the relationship between Volts and Amperes?
As V=IR is the most basic equation in electricity, A=L+E is the most basic equation in business. It's necessary to understand them in order to pontificate about them, instead of just making things up.
The interest can be treated as finance cost, and amortized over time.
Rather than going straight on the balance sheet, it goes on the income statements (which are change in balance sheet) a little bit each statement period.
This makes the company's performance look less spiky, making it easier to reason about (from a pure profit/loss perspective, not a cashflow one) and less scary to shareholders.
It also matches with the way the rest of the balance sheet is reported (current value). For example: if you have some aspect of the business which you believe will appreciate in value over time, you probably shouldn't immediately book the increase at the as-yet unrealized future value.
It didn't, but companies don't issue debt just to have it sit on their balance sheet. Presumably, the additional capital is put to use in projects with an expected return that is greater than the cost of capital (usually the weighted average between (i) the equity holder's required return on equity and (ii) the cost of debt that is usually expressed in the form of the interest rate, to keep it simple).
Taking on debt is always done with the purpose of creating value. Sometimes it fails, but that doesn't mean failure was the objective.
Accrued interested is added to the Liability as time goes on, but it is not there on Day 0. Furthermore, businesses borrow money in order to use it to increase assets, not just sit in a pile.
I'm pretty sure there are loans where it is, or at least a portion of it is, or at a bare minimum there's an early repayment fee. It would not surprise me to learn that in the world of business finance, these happen. It also wouldn't surprise me to learn that these are used creatively to shift money between entities.
As any corporate finance book will teach you, increasing leverage simply means returns to equity holders are more volatile.
It's like adding debt to a lemonade stand that generates $1 a day everyday for the chance of instead generating $5 or ($5) everyday.
People (managers, investors..) have varying appetites for risk, but at the end of the day, these are all consenting adults and they can do as they please within the limits of the law.