Question

The availability of bank credit is often more important to a small firm than to a large one. Why? Answer must be more than 200 words.

Answer 1

Credit is required by all companies in order to expand their business or take advantage of financial leverage in order to increase its return on equity. Using debt helps to increase their return on equity as debt payments are fixed and if profits are higher than those previously then advantages of using leverage can be achieved.

As we have established the importance of using debt/ leverage in firms as general, we shall now focus on why bank credit specifically is more important for small firms than large ones.

In case of large firms, bank credit is predominantly just one type of financing vehicle. Large firms have the option to choose from various other financing options such as issuing equity shares, preference shares or even their debt for that matter. Large firms, as their name suggests are firms that have established themselves in the industry and thus investors would also be willing to invest in the equity, preference and debt securities issued by them.

On the other hand, small firms are those that have not yet been established in the industry. These are yet in their growth phase and do not have the options to raise their financing needs by the issue of equity, preference or debt securities. Hence, the only available option for them is to avail bank credit in order to finance their needs.

Hence, availing bank credit remains as the only alternative for small; firms to finance themselves, but not for large firms. Thus, we can conclude that the availability of bank credit is often more important to a small firm, than to a large one.