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 assetsTotal AssetsTotal Assets is the sum of a company's current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equity of the company to check if the organization has enough support to overcome its debt. This Book value can be found in the Balance SheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. under Long Term Liability and Current liability head.Current Liability Head.Current Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.
Book Value of Debt – Components
It consists of the following components in the balance sheet,
- Long term DebtLong Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability., it will be founded in long term liability head in the balance sheet.
- Current portion of Long-term DebtCurrent Portion Of Long-term DebtCurrent Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets., it will be the part of Current liability head in the balance sheet.
- Promissory NotesPromissory NotesA promissory note is a negotiable instrument that represents the debtor's or the writer's (the maker's) written consent to pay a promised sum to the creditor (the payee) on a specified date. (Note PayableNote PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. ), 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
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 LiabilitiesComponents In The Current LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc..
Long-term Liabilities include Long term loans 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 of March 31st, 2019. We will look at the liabilities side to find out the 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:
- The 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 the 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 a 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 companyAnnual Financial Statements From The CompanyAnnual Financial Statements refers to the annual presentation of the entity's financial performance comprising a Balance Sheet, statement of profit and loss, statement of changes in equity, cash flow statement, and notes to the financial statements. It provides information to the stakeholders for making financial decisions about the business..
- 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 ValueTotal Enterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover..
- 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 companyNet Debt Of The CompanyDebt minus cash and cash equivalents equals net debt, which is the amount of debt a company has in comparison to its liquid assets. It is a metric that is used to evaluate a firm's financial liquidity and aids in determining if the company can meet its obligations by comparing liquid assets to total debt.. 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 the company’s financial statement, so only after a quarter or annual financial statement reporting, the investor would be aware that how the 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 –