Although this insightful quote by Mr. Smith should be taken to heart in the wake of the recent financial crisis, in today's modern economy businesses play by a different set of rules.

It is a commonly understood (but often ignored) rule that debt is a crutch for a business, the point proven by the collapse of the banking industry. Nevertheless, many businesses who are financially strong continue to issue debt, which begs the question...why? If a company has the cash and is in a strong financial position, why would it elect to issue debt instead of spending the cash it has?

There are a few reasons:

The first is opportunity cost. That chunk of money they have could be used to get higher returns somewhere else. If they can borrow from a bank at low interest rates to finance their ongoing operations, they can use their cash to get a higher return somewhere else.

The second is credit rating. For public companies, ratings companies give high emphasis to companies with large reserves. This strengthens their ability to pay back the loan should it become necessary. A good credit rating in turn let's the company borrow money at lower rates. When a company can borrow money at low rates, it circles back to the first point where they can now put their reserves to better use.

The third is leverage. Companies can use the cash they have built up to leverage into a larger investment. Assuming the investment works out, it will pay for the cost of borrowing over time. For instance let's say I have $1 million to invest. I can pay all cash for a $1 million apartment building or I can leverage that into a $3 million building. Assuming I run it well, the tenants will pay for the cost of borrowing $2 million and at the end of the term I'll be left with my $3 million building.

For individuals and businesses that have a thorough understanding of it, debt can be a tool to strengthen their economic position and produce superior returns.

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