Borrowed Money?

By Al Thomas

Looking at a corporate balance sheet many times it shows huge amounts of debt. Debt is a drag on the company’s profits, but can be used to increase profit.

If a company borrows $100,000 at 8% interest rate then it has obligated a cost of $8,000 annually. ABC Co. manufactures widgets. Each widget has a wholesale selling price of $100. Cost of materials for each unit is $40. Labor is $20, sales $15, overhead is $15 that leaves the company with a $10 gross profit, 10%. This is considered exceptionally good as the standard for most industries is 5%. $10 per unit net profit.

ABC wants to expand their manufacturing plant, buy more machinery and hire more people. Their net will not allow them the $200,000 cash they need to do it. After a meeting with their banker they are able to negotiate a loan that will cost them $3.00 per widget. Assuming all their costs remain the same their net is now $7.00 profit per unit, but they will be making twice as many.

Many times companies can produce twice the product with borrowed funds. It does not shrink the bottom line as some of the previous overhead can be amortized into the expanded production. We won’t go into that here.

Debt that can produce more income is a good thing. If it cannot it should not be taken on.

Look at government debt. Where does repayment come from? Since government produces nothing there is only one source. Taxes. The taxes are extracted from the citizens who work.

Not only does debt have to be repaid, but interest must be paid on it every year. The governments, local, state and federal, levy taxes. There is a limit how high taxes can go as people will stop working at productive jobs if their take home pay shrinks to the point where they do not feel compensated for their effort.

The media talks about GDP – Gross Domestic Product. Most people have no idea what it is. It is the sum total of all goods and services produced in a country. Very simply when the income from taxes gets to the point where the government can’t pay for the services including interest on the debt the government is broke. The U.S. is getting close to that magic number.

Iceland went broke and quit paying its debt. Many European countries such as Portugal, Italy, Ireland, Greece, even the UK is teetering on the edge of default. You can’t borrow your way out of debt when there is not a product that produces a profit or enough people to pay taxes. Every government worker, program and project is a liability. Only businesses produce income.

Stimulus money is debt that is nonproductive to be repaid by us, our kids and their kids. It can only lead to higher taxes and a lower standard of living.

When a company can’t pay its debt it goes out of business. When a government defaults the system collapses and it is every man for himself called anarchy.

Al Thomas’ book, “If It Doesn’t Go Up, Don’t Buy It!” has helped thousands of people make money and keep their profits with his simple 2-step method. Read the first chapter at http://www.mutualfundmagic.com and discover why he’s the man that Wall Street does not want you to know. Copyright 2010 Williamsburg Investment Co. All rights reserved.
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