Corporate debt can strengthen a company or weaken an investment before the risk shows up in the share price. Borrowing is not automatically harmful, and having no debt is not always a sign of strength.

For stock investors, the question is what the company gets from borrowing and what it gives up in return. The debt balance is only a starting point.

Debt Basics

A company takes on debt when it borrows money that it must repay, usually with interest. It can borrow through loans from financial institutions or by issuing bonds to investors. Both give the business access to capital, but both create payment obligations that leave it less flexibility if income falls.

Existing Debt

Start with how much debt is already on the balance sheet. A company that carries little debt may have room to borrow for an expansion. A company with substantial obligations may have less cash left to invest in the business after paying interest and repaying what it borrowed.

Why the Company Borrowed

Borrowing to fund expansion or improve production can make financial sense if the project earns more than the financing costs. Loans can also cover ordinary needs such as payroll or inventory. The warning sign is when a company repeatedly needs new borrowing to meet routine expenses it cannot cover from operations.

Repayment Timing

The repayment schedule should fit the purpose of the loan. Short-term borrowing for a long-term project can create pressure if the debt comes due before the project starts generating cash. A longer term gives the company more time, but it does not make an expensive loan affordable.

According to Aswath Damodaran, a finance professor at NYU Stern, a company can reduce the risk of missing payments by matching the timing of debt payments to the cash generated by the assets it financed.

Refinancing Risk

Refinancing means replacing existing debt with new borrowing. If the new debt carries a lower rate, the company may reduce its interest expense. But refinancing because it cannot repay what is due leaves the company dependent on lenders being willing to lend again, possibly on worse terms.

Interest Costs

High interest costs can weaken even a growing company. Sales may rise, but that does not guarantee higher profits for shareholders. Look at how much of the improvement in operating profit is absorbed by interest expense rather than assuming that revenue growth will benefit the stock.

Cash Flow Under Pressure

Check whether the cash the business generates from operations is enough to cover interest and scheduled repayments. A particularly strong quarter is a poor baseline. Consider whether the company could still pay on time if an expansion took longer than planned to produce cash or if sales slowed.

Loan Conditions

Debt agreements can contain conditions known as covenants. Some require a company to maintain certain financial ratios. Depending on the agreement, breaking a covenant may allow a lender to demand earlier repayment. That can create a cash shortfall when the company is already dealing with weaker sales.

Industry Comparisons

Compare the company with peers rather than looking for a debt level that fits every industry. The debt-to-equity ratio shows how much debt a company carries relative to shareholders’ equity. The current and quick ratios address a different question: whether short-term assets can cover short-term obligations.

What Shareholders Stand to Lose

If a company runs into financial trouble and its assets are sold to pay claims, lenders generally get paid before common shareholders. Shareholders receive only what is left after higher-priority claims are paid. A large debt balance can therefore increase the downside for stockholders even when the business is still growing.

Before buying the stock, open the debt notes in the company’s latest financial statements. Mark the periods when the largest repayments are due, then use those dates to check whether management’s plans leave enough room for a delay.