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Abstract

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Introduction

1.1 BACKGROUND OF THE STUDY



In contemporary business setting, debt is seemingly inevitable. Sometimes it emanates from short fund convenience with the prevailing trade terms. Debt does not occur only when money is borrowed. It equally occurs when there is exchange of goods or services with a deserved payment. So each time goods or services are exchanged with a different of its financial obligation, there is incidence of debt.



A good business may not always write to finances the commencement of his business from his personal savings. If he does, so many things may happen. Either that the business is under financed or the business is foregone, likewise a business firm for one version or the other may not finance through equity aware only. The management may wish to source the fund through debt. Even after the commencement, the firm may further need extra funds for expansion or for speculative purposes. Hence, this project work looks into the analysis of debt in a dual perspective:



i. In the accumulative of fund, either for the commencement or expansion and



ii. In trading relationship (trade debt).



(i) At the commencement of a consciences organization, the owners try to maintain a favourable capital structure. Ordinarily, it is normal for the business owners (equity holder) to finance the business. But more often, the funding of a business goes beyond that. The choice of the capital structure and the funding technique is left at the mercy of the financial managers. On doing so however, he doesn’t overlook or neglect the major organizational objective; maximization of the owners wealth.



Business organizations usually strive to achieve a number of objectives. These corporate objectives provide a set of criteria upon which financial decisions can be based. In general terms of business organization seek to achieve by obtaining funds from various sources and investing some reasonably. It is important to recognize that the various types of funds raised has its own cost and each has certain risks. For example, loans (secured and unsecured), debentures, preference and ordinary shares. Loans raised ob the security organizations assets tend to have fairly low rates of interest although they imply certain risks. Failure to meet the terms of the loan on the due date would empower the tender to confiscate the said assets with potentially catastrophic consequence for the borrower.



In contrast, an unsecured loan on which no assets is pledged, though escaped the last cited risk cost higher. It has higher cost than the former. Preference share on the other hand may have a relatively annual rate but its payment is binding irrespective of whether profits were made or not.



Ordinary share however has no fixed charge as such. Its dividend depends on the periodic business profits yet excessive use of equity shares is determine to the organizational control, if it is not technically handled. When the equity share is used in marginal funding of the firm, it is only advisable when the return from the issue is such that share prices would increase. One would not expect an issue of share to be made with an expectation that share prices would fall since that would reduce shareholders wealth. So it can be said that the minimum return required from a new issue is that which would leave the share price at its present level.



Since it is one of the organizational objectives to maximize the equity holders, wealth and random use of ordinary shares tantamount this. The management would have no option than to resort to debt financing to complement equity. This is one of the reasons why debt financing is almost inevitable in the capital structure of a business organization of today. Then with the attendant risk and return relationship, the financial manager always seeks for a fair equilibrium to the best interest of the firm for its survival and for attainment of its set objectives.



(ii) Trade Debt: - with the exception of most types of retaining commercial sales are usually made on credit. This means that cash settlement legs sometimes behind the delivery of the goods or the consumption of the service to which the payment relates. The main reason for these practices are attributed to the present commercial tradition for convenience aid to the buyers and even to the sellers. This trading terms leads to debt but it is encouraged for the following reasons



a) The recipient will need to assure himself that the goods are satisfactory prior to payment.



b) Additional safeguard will need to be introduced with regards to the cash collected.



Even when and where it would be reasonable practicable to pay on delivery, customers are reluctant to forgo the traditional credit period. Since they do so, it would increase their own financing costs.



The practice of allowing credit has thus come to be widely accepted as normal. The use of credit however has certain costs associated with it and the analyzing debt management requires a clear identification and balancing of these various costs. To achieve this however, the financial manager and the management had to consider the costs under two categories:



a) Cost of allowing credit.



b) Cost of refusing credit.