Book Value of Debt Definition
Book value of debt is the total amount which the company owes, which is recorded in the books of the company. It is basically used in Liquidity ratios where it will be compared to the total assets of the company to check if the organization is having enough support to overcome its debt. This Book value can be found in the Balance Sheet under Long Term Liability and Current liability head.
Book Value of Debt – Components
It consists of the following components in the balance sheet,
- Long term Debt, it will be founded in long term liability head in the balance sheet.
- Current portion of Long-term Debt, it will be the part of Current liability head in the balance sheet.
- Promissory Notes (Note Payable), it would be found in current liability head in the balance sheet.
Book Value of Debt Formula
Below is the Formula to calculate Book Value of Debt
Book Value of Debt Formula = Long Term Debt + Notes Payable + Current Portion of Long-Term Debt
How to Calculate Book Value of Debt?
It is calculated to make a sum of money borrowed and is due to be paid in the Balance sheet. All we need to do is to add all the long-term Liabilities and some of the components in the Current Liabilities.
Long-term Liabilities include Long term loan from Banks or other financial institutions and Debentures. From the balance sheet, one can easily calculate this Book value.
let’s take one example.
Below is the balance sheet of M/s XYZ Corporation as on March 31st, 2019. We will look at the liabilities side to find out total debt in the company.
We can see in the above balance sheet of M/s XYZ Corporation, the Total long-term Debt is USD $ 200,000 and Notes Payables is USD $ 10,000.
The next step is to calculate the book value of debt by employing the above formula,
- Book Value of Debt = Long Term Debt + Notes Payable + Current Portion of Long-Term Debt
- =USD $ 200,000 + USD $ 0 + USD $ 10,000
- = USD $ 210,000
So, we can see that the Debt for XYZ Corporation is USD $ 210,000 which would be different from the market value of debt.
It has many advantages as compared to the market value of Debt. Below are the main advantages one can see with it,
- Easy to Calculate: It is easy to calculate, as per the above formula, we can calculate it by looking at the Balance sheet of the company. We have to add all Long-term liabilities and current liabilities which will give Book value of Debt.
- It gives us the actual value of debt which a company owes to its lenders or other stakeholders which is recorded in the books.
- This Book value changes only when the company updates its financial statements quarterly or annually and it does not change as per the market situations.
As we have seen some of the advantages, but this has some disadvantages as well, some of them are as follows:
- Book value of Debt is not so accurate when it compares with the Market value of Debt. As it is derived directly from the financial statements, so it is not affected by current market situations or interest rates.
- It changes over periodical intervals i.e. monthly, quarterly or annually. If someone wants to know the current book value of Debts, he has to wait for updated financial statements.
- Book value of debt is accounting value of the debt which was recorded as per the historical data or amortization schedule of the debt, which will have less relevance at the time when the company is looking for merger or acquisition or looking for any other external investors for the company.
There are some limitations of Book Value of Debt when it compares to Market value of Debt, some of the major limitations are as follows,
- One of the major issues with the Book value of Debt is that all financial statements are updated quarterly or annually. If one wants to see the exact amount of debt from the financial statement, one has to wait for quarterly or annual financial statements from the company.
- It would be adjusted as per the accounting standards and would be subject to adjustment which is not easy to understand and track.
- It does not give the exact position of the net debt which the company would be having actually. To get the exact position of the net debt, we have to consider the market value of Debt.
- It could be used for empirical finance only as it does not consider the current market situations and interest rates for calculating a net debt for the company.
- It does not help stakeholders and investors in calculating the company’s total Enterprise Value.
- Book value of debt is accounted for in the financial statements based on the amortization schedule of the debt or historical cost.
Effect of Changes in Book Value of Debt
It is the sum of the total debt recorded in its balance sheet and is useful in calculating of Liquidity ratios of the firm. So changes in book value of Debt will affect in the following manner,
- Changes in this Book value will definitely affect its liquidity ratios. Liquidity ratios are useful in knowing the firm’s capability in supporting its total debt.
- If the Book value of debt has increased over time, it means that company’s capability has decreased in supporting its total debt, which means that as compared to its total assets, the company has more debt in its balance sheet and in future it would be difficult for the company to pay off its debt.
- The company has to put its assets as collateral with the banks or other financial institutes, so changes in this book value will also affect the value of the collateral securities with the banks or other financial institutes.
So, from the above discussion, we can conclude this in following heads,
- It is the total money which the company owes and recorded in the books of the company.
- It is one of the things to look at when we are investing or loaning the money in any company. Yet it is not an accurate way to calculate the total net debt of the company. We have to consider the market value of debt for a proper understanding of the company.
- It is the sum of Long-term debt, Current portion of long-term debt and notes payable in the balance sheet.
- It is useful to calculate liquidity ratios of the company to see if the organization has the capability of supporting its debt load.
- One of the main limitations of the book value of Debt is that it is updated quarterly or annually with company’s financial statement, so only after a quarter or annual financial statement reporting, the investor would be aware that how company’s book value has changed over the time.
- It may be different than the market value of the firm.
This has been a Guide to Book Value of Debt and its definition. Here we look at how to calculate Book value of debt, its formula along with examples, advantages, disadvantages, and limitations. You can learn more about financing from the following articles –