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 balance sheet are those loans and other liabilities, which are not going to come due within a period of 1 year from the time when they are created. In general terms, all the non-current liabilities can be called long-term debts, especially for the purpose of finding 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 a number of years to follow.
- Thus, they mature over many years; 10-year bonds, 20-year bonds or 30-year bonds for example. This 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 “current portion of long-term debt”. When an entity issues a debt, some of its portion needs 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 liabilities 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 an 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 an access to the full amount of debt immediately, it can structure the debt in a manner so as 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. In fact, the interest paid during a period is reported on the income statement of that period as an expense. Since it is an expense reported 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 expenses 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 leverage that it provides to the company. Leverage is a very important 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 balance sheet has increased over the past 10 years. Also, its debt to total capital has also increased over the corresponding period. This implies that Pepsi has been relying on debt for growth.
Oil & Gas Companies Example
Oil and Gas Companies are capital intensive companies that raise large amounts of long-term debt on 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 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. This 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 company.
- 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 ratio 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, the 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 a stable cash flow as compared to start-ups and early-stage companies. This is because the latter prefer 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 dilution. If the company raises the debt for an acquisition, again the resulting synergies need to be analyzed in order to know the impact of it.
- Lastly, if the long-term debt on 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 flows 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 shareholders.
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 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 –