What is Long Term Debt?
Long term debt is the debt taken by the company which gets due or is payable after the period of one year on the date of the balance sheet and it is shown in the liabilities side of the balance sheet of the company as the non-current liability.
In simple terms, Long term debts on a balance sheet are those loans and other liabilities, which are not going to come due within 1 year from the time when they are created. In general terms, all the non-current liabilities can be called long-term debts, especially to find financial ratios that are to be used for analyzing the financial health of a company.
- They are issued as bonds by companies to finance their expansion over several years to follow.
- Thus, they mature over many years; 10-year bonds, 20-year bonds, or 30-year bonds, for example. It is a very common practice, especially in all the capital-intensive industries all around the globe. Hence, bonds are the most common types of long-term debt.
- There is also something called the “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..” When an entity issues a debt, some of its portions need to be paid every year (or period) till the time the principal amount of that debt has been fully paid back to the creditor.
- Due to this, even if the whole debt is of the long-term nature, the portion of the principal that is required to be paid back within the current year cannot be categorized under the long-term Debt. Therefore, that portion is written under current liabilitiesCurrent 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. as “current portion of long-term debt.”
Long-Term Debt Example
Below is a long-term debt example of Starbucks. We note that Starbucks debt increased in 2017 to $3,932.6 million as compared to $3185.3 million in 2016.
source: Starbucks SEC Filings
Below is its breakup
source: Starbucks SEC Filings
As we note from above, the company has issued various debt notes (2018 notes, 2021 notes, 2022 notes, 2023 notes, 2026 notes, and even 2045 notes)
- Debt gives a company immediate access to the required amount of capital without having to pay it back to the lender in the near term. If the company does not want access to the full amount of debt immediately, it can structure the debt in a manner to receive it in parts over a period of time as and when required.
- For any kind of debt, there is an interest payment involved apart from the payment of the principal amount. This interest payment is always a current item. The interest paid during a period is reported on the income statement of that period as an expense. Since it is an expense reportedAn Expense ReportedAn expense report refers to a form served for requesting reimbursement or disclosing all the monthly, quarterly or yearly spendings an employee does on the company's behalf. In most cases, the expense receipts are also attached with it for evidence. before the tax, it also reduces the taxable income of the company and eventually, the tax to be paid by the company.
- But that is not the real advantage of taking a long-term debt on balance sheet since the company, in this case, is increasing its expensesExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities. to decrease its tax, which it could do by increasing any other expense (like the cost of inventory purchased) as well.
- The real advantage is the financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. that it provides to the company. Leverage is a critical term in financial jargon, as well as in the financial analysis of a company.
Pepsi’s Long-Term Debt Example
As we note from above, Pepsi’s long-term debt on the balance sheet has increased over the past 10 years. Also, its debt to total capital has increased over the corresponding period. It implies that Pepsi has been relying on debt for growth.
Oil & Gas Companies Example
Oil and Gas Companies are capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining. companies that raise large amounts of long-term debt on the balance sheet. Below is the Capitalization ratio (Debt to Total Capital) graph of Exxon, Royal Dutch, BP, and Chevron. We note that for all the companies, debt has increased, thereby increasing the overall capitalization ratio.
This increase in long-term debt on the balance sheet is primarily due to a slowdown in commodity (oil) prices and thereby resulting in reduced cash flows, straining their balance sheet.
|Period||BP||Chevron||Royal Dutch||Exxon Mobil|
The Negative Impacts of high Long-Term Debt
- Although issuing debt provides the benefits described above, too much debt is also injurious to the health of a company. It is because one must realize that what has been borrowed must be paid back at some point in time in the future. And apart from the principal amount, there would be a recurring interest cost as well.
- Therefore, the debt level of a company must be at an optimal level compared to its equity so that the current portion of the debt and the interest expenses together don’t eat up the cash flow from operations of the companyCash Flow From Operations Of The CompanyCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital..
- Remember, if a company issues equity, it is not a compulsion to pay the dividends. But if it issues debt, then interest payment is mandatory.
Important Note for Investors
- As an investor, it is advisable to keep a watch on the debt to equity ratioDebt To Equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. and other debt-related ratios and indicators. An investor must also be attentive to any change or restructuring of his company’s debt.
- An investor must know the industry norms regarding the capital structure of the companies of a particular industry. Generally, more asset-heavy companies raise more capital in the form of debt. And the assets like plant and equipment are built as long-term projects. So, in the asset-heavy industries like the steel industry and the telecommunication industry, the proportion of debt is generally high.
- High debt levels are more a characteristic of mature companies, which have stable cash flow as compared to start-ups and early-stage companies. It is because the latter prefers not to raise debt as it attracts financial charges, including interest expenses.
- One also needs to dig out the reasons behind the issuance of any new debt by the company. Whether the debt has been issued to fund growth or to buy back some shares or acquire a company or simply to fund the operating expenses, if it is to fund growth, it’s a good sign for the investors. If it’s for a share buyback, more analysis is required, but it is mostly good because it decreases equity dilutionEquity DilutionEquity dilution is a method used by the companies to raise capital for their business and projects by offering ownership in exchange. This process, therefore, reduces or dilutes the privilege of existing owners.. If the company raises the debt for acquisition, again, the resulting synergies need to be analyzed to know the impact of it.
- Lastly, if the long-term debt on the balance sheet is raised to finance the operating expenses, it gives a negative signal in the market. And if it happens frequently, it means that the company’s operations are not able to generate enough cash flows required for funding the operating expenses. Therefore, a good investor must always be very alert and informed about whatever new debt issuance or restructuring takes place in the company in which he/she has invested or is planning to invest.
Long-term debt is the debt, which needs to be paid back to the lenders in more than one year from the time it is borrowed. It is helpful for companies because it provides some financial leverage if the company is able to generate enough cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. to cover its interest costs. However, if the debt is too much compared to its operating cash flows, it invites trouble for the company as well as the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares..
Therefore, an investor must study the debt and the changes happening in it carefully. It is a good practice to be informed about the purpose of any new debt issued or restructured and also the composition of the long-term debt. For getting those details, an investor must go through the notes to the financial statements and the conference calls conducted periodically by the company he/she is interested in.
Long-Term Debt on Balance Sheet Video
This article has been a guide to what is long-term debt on the balance sheet. Here we discuss long-term debt examples along with its advantages and disadvantages. We also discuss the things that you must know as an investor about debt. You can also have a look at these articles below to learn more about accounting –