Question 8.15: What factors are likely to influence the ability of a busine...
What factors are likely to influence the ability of a business to repay the amount bor-rowed and to pay interest at due dates?
The following factors are likely to be important:
● Profitability. Where a business has a stable level of profits, lenders may feel that there is less risk to their investment than where profits are volatile. Profit stability will depend on such factors as the nature of the products sold, the competitive structure of the industry and so on.
● Cash-generating ability. Where a business is able to generate strong, predictable cash flows, lenders may feel there is less risk to their investment.
● Security for the loan. The nature and quality of assets held by a business will determine whether there is adequate security for a loan. Generally speaking, lenders prefer assets that have a ready market value, which can be easily transferred and which will not deteriorate quickly (for example, property).
● Fixed operating costs. A business with high fixed operating costs has high operating risk as these costs have to be paid irrespective of the profits earned. By taking on commitments to make interest payments, the business may increase its total risk to unacceptable levels.
This is not an exhaustive list: you may have thought of other factors.