When the Clinton admiral ration unveiled plans to offer “Nondenominational” bonds, some Wall Street wags likened.the proposal to p. meddling flood Inline. race In the Delbert Indeed, with the Federal Reveler having apparently Ingrain the Inflation beast, many parole law little need for the Luxuriance the bonds would provide against a Sharp luge In princely. And Since theme bond were expected to offer a lower Interpreter rate as the trade-off for the Insurance, many experts ecol undertaking a poll.
But a funny thing happened after the government’s latest auction of the Inflation bonds:.Thanks to Wall Street telephonist
•.now.offer a real return.almost highs a$ conventional Treasures of the lame maturity. And with recent economic report suggestible that inflation may not be dead after all, lame think the Indexed bonds-which pay a fixed Interest rate plus a sweet· pegged to the consumer price Index (CPI)-are now worthy of a look. Source: Dean
These Bonds Looked Like Losers. They’re Not,” Business Week, May 5, 1997. Reprinted by special permission, copyright <C>1997 by The Companies. Inc.The federal government its operations in two basic ways: by taxing and by borrowing.
The sale of “inflation~indexed” bonds introduced by the Clinton administration is one of many ways that the government engages in debt financing (or borrowing activities). Businesses also have two financing alternatives: with debt or with equity.
The mix of liabilities and owners’ equity in a particular business is termed the company’s capital structure. In the preceding three chapters, we have discussed the major groups of business assets. We will now shift our attention to the right side of the balance sheet and examine those issues involving a company’s capital structure ln this chapter, we emphasize liabilities; in the next two chapters, we focus on various components of owners (or stockholders equity.
The Nature of Liabilities.Liabilities may be defined as debts or obligations arising from past transactions or events and requiring. settlement at a future date .
All lab lilies have certain characteristics in common; however, the specific terms of different liabilities, and the rights of the creditors, vary greatly Distinction between Debt and Equity.
Business have two basic sources of financing: liabilities and owners’ equity Liabilities differ from owners’ equity in .several respects. The feature that most clearly distinguishes the claims of creditors from owners’ equity is that all liabilities eventually mature that is, they come due.
‘Owners’ equity does not mature, The date.on which a liability’ comes due is called the maturity date. Although all liabilities mature, their maturity dates vary. Some liabilities are so short in term that they are paid before the financial statements reach the users’ desk.
Long-term liabilities, in contrast, may not mature for many years. The maturity dates of key liabilities may be a critical factor in the solvency of a business.
The providers of borrowed capital are creditors of the business, not owners. As creditors, they have financial claims against the business but usually do nil have the right to control business operations.
The.traditional roles of owners. manglers, and creditors may be modified, however, in an indenture contract. Creditor .sometimes insist on being granted some control over business ‘operations as a condition of making a loan, particularly if the business is in poor financial condition. Indenture contracts may impose such restrictions as limits’ .on. management’ salaries in on dividends and may require the creditor’s approval for additional borrowing,. or for large capital expenditures.
The claims of creditors have. legal priority over the of owner. If a business ceases operations and liquidates, creditors must be Paid in/ul/ before’ any distributions are made to the owners. The relative security of noncredit’ claims. however, can vary among the creditors. Sometimes the borrower pledges title specific assets as collateral for a loan.
If the borrower defaults a secured loan, the. creditor may foreclose on the pledged assets. Assets that have beep security for 1000ns should be identified in notes accompanying the borrower’s financial statements.Liabilities that are not secured by Specific termed general credit obligations. The priorities of general credit obligations vary with the nature of the liability and, the terms of indenture contracts.
Many Liabilities Bear Interest Many long-term Liability hand some short-term ones, require the borrower to pay interest. Only interest accrued, as Of the balance sheet date appears as a liability in the borrower’s balance sheet.
The borrower’s’ obligation to pay interest in future’ periods sometimes is disclosed in the notes to the financial statements but it is not shown as an existing liability Estimated Liabilities Most liabilities are fora.definite· dollar amount; clearly stated by contract.
Examples include notes payable, accounts payable; and accrued expenses, such as interest payable and salaries payable. In some.cases, however, the dollar. amount of a liability must be estimated ‘at the balance sheet date. Estimated liabilities have two basic characteristics: The liability is known’ (0 emf, .and the precise dollar amount cannot be determined until a later date. For instance, the automobiles sold by most automakers are accompanied by’ a warranty obligating the cash.
Some liabilities are due on demand. which means that the liability is payable upon the creditor’s request. From a bank’s point of view: customers’ checking accounts are “demand liabilities,” Liabilities due on demand may come due at any time and are classified as current liabilities automaker to replace defective parts for a period of several years, As each car is sold, the automaker incurs a liability to perform any work that may be required-under the warranty The dollar amount of this liability, however, can only be estimated