Net debt – Definition

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What is net debt?

Net debt is a measure of liquidity used to determine how well a business can pay off all of its debts if they were due immediately. Net debt shows a company’s indebtedness on its balance sheet relative to its cash flow. Net debt shows how much cash would be left if all debts were paid off and a business had enough cash to honor its debts.

Formula and calculation of net debt

To determine the financial stability of a business, analysts and investors will look at net debt using the following formula and calculation.














Net debt


=


STD


+


SARL




CCE
















or:





















STD


=









Debt due in 12 months or less
















and may include a short-term bank
















loans, accounts payable and leasing


























SARL


=









Long-term debt is debt that, with a
















maturity date greater than one year
















and include obligations, lease payments,


























CCE


=









Cash and liquid instruments that can be





















Cash equivalents are liquid investments with a
















maturity of 90 days or less and include
















certificates of deposit, treasury bills and








begin {aligned} & text {Net debt} = text {STD} + text {LTD} – text {CCE} & textbf {where:} & begin {aligned} text { STD} = & text {Debt due in 12 months or less} & text {and may include short-term bank loans} & text {loans, accounts payable and leasing} & text {payments} end {aligned} & begin {aligned} text {LTD} = & text {Long-term debt is debt that has a} & text {date d ‘maturity greater than one year} & text {and include bonds, lease payments,} & text {term loans, small and notes payable} end {aligned} & begin {aligned} text {CCE} = & text {Cash and liquid instruments that can be} & text {easily converted to cash.} end {aligned} & text {The equivalents of cash are liquid investments with a} & text {maturity of 90 days or less and include} & text {certificates of deposit, treasury bills and} & text {commercial paper} end { aligned}



Net debt=STD+SARLCCEor:STD= Debt due in 12 months or less and may include a short-term bank loans, accounts payable and leasingSARL= Long-term debt is debt that, with a maturity date greater than one year and include obligations, lease payments,CCE= Cash and liquid instruments that can beCash equivalents are liquid investments with amaturity of 90 days or less and includecertificates of deposit, treasury bills and

  1. Total all of the short-term debt amounts on the balance sheet.
  2. Total all of the long-term debt listed and add the number to the total short-term debt.
  3. Add up all cash and cash equivalents and subtract the result from total short-term and long-term debt.

What Net Debt Indicates

The net debt figure is used as an indication of a company’s ability to repay all of its debts should they become due simultaneously on the calculation date, using only its available cash and highly liquid assets called cash equivalents.

Net debt is a measure of whether a business is over-leveraged or over-leveraged given its liquidity. Negative net debt implies that the business has more cash and cash equivalents than its financial obligations and is therefore more financially stable.

Negative net debt means that a business has less debt and more liquidity, while a business with positive net debt means that it has more debt on its balance sheet than liquid assets. However, since it is common for companies to have more debt than cash, investors should compare a company’s net debt with other companies in the same industry.

Net debt and total debt

Part of the net debt is calculated by determining the total debt of the business. Total debt includes long-term liabilities, such as mortgages and other loans that fail to mature for several years, as well as short-term obligations, including loan payments, credit cards and balances. accounts payable.

Net debt and total cash

Calculating net debt also requires determining the total cash flow of a business. Unlike the debt figure, total cash includes cash and highly liquid assets. Cash and cash equivalents would include items such as checking and savings account balances, stocks and certain marketable securities. However, it is important to note that many companies may not include marketable securities as cash equivalents as it depends on the investment vehicle and its sufficient liquidity to be converted within 90 days.

Complete debt analysis

While the net debt figure is a good place to start, a prudent investor should also take a closer look at a company’s debt level. Important factors to consider are the actual debt numbers – short term and long term – and the percentage of total debt that needs to be paid off in the coming year.

Debt management is important for businesses because it is well managed, they should have access to additional finance if needed. For many businesses, securing new debt financing is critical to their long-term growth strategy, as the proceeds can be used to fund an expansion project, or to pay off or refinance older or more expensive debt.

A business can be in financial difficulty if it has too much debt, but debt maturity is also important to watch. If the majority of the company’s debts are short-term, which means the bonds must be repaid within 12 months, the company must generate enough income and have enough liquidity to cover future debt maturities. . Investors should consider whether the company could afford to cover their short-term debts if the company’s sales decline significantly.

On the other hand, if the company’s current source of income is only paying its short-term debts and is not able to adequately repay its long-term debts, it is only a matter of time before the business faces difficulties or needs an injection of cash or financing. Because companies use debt differently and in many forms, it is best to compare a company’s net debt to that of other companies in the same industry and of comparable size.

Key points to remember

  • Net debt is a measure of liquidity used to determine how well a business can pay off all of its debts if they were due immediately.
  • Net debt shows how much cash would be left if all debts were paid off and a business had enough cash to honor its debts.
  • Net debt is calculated by subtracting a company’s total cash and cash equivalents from its total short-term and long-term debt.

Example of net debt

Company A has the following financial information listed on its balance sheet. Businesses generally break down whether debt is short or long term.

  • Accounts Payable: $ 100,000
  • Line of credit: $ 50,000
  • Term loan: $ 200,000
  • Cash: $ 30,000
  • Cash equivalents: $ 20,000

To calculate net debt, we first need to add up all debt and add up all cash and cash equivalents. Next, we subtract the total cash or liquid assets from the total amount of debt.

  • The total debt would be calculated by adding the debt amounts or $ 100,000 + $ 50,000 + $ 200,000 = $ 350,000.
  • Cash and cash equivalents are totaled or $ 30,000 + $ 20,000 and equivalent to $ 50,000 for the period.
  • Net debt is calculated from $ 350,000 to $ 50,000, which equals $ 300,000 of net debt.

Net debt vs debt / equity ratio

The debt ratio is a ratio of financial leverage, which indicates the extent to which a company’s funding or capital structure is made up of debt compared to the issuance of shares. The debt-to-equity ratio calculated by dividing the total liabilities of a business by its equity and is used to determine whether a business is using too much or too little debt or equity to finance its growth.

Net debt takes it to another level by measuring the total amount of debt on the balance sheet after factoring of cash and cash equivalents. Net debt is a measure of liquidity while the debt to equity ratio is a leverage ratio.

Limits on the use of net debt

While it is generally perceived that companies with negative net debt are better able to withstand downward economic trends and deteriorating macroeconomic conditions, too low leverage can be a warning sign. If a company does not invest in its long-term growth due to lack of debt, it could fight against competitors who invest in its long-term growth.

For example, oil and gas companies are capital intensive, which means they must invest in large capital assets, which include tangible capital assets. As a result, companies in the industry typically have a significant portion of long-term debt to finance their oil rigs and drilling equipment.

An oil company should have positive net debt, but investors should compare the company’s net debt with that of other oil companies in the same industry. It doesn’t make sense to compare the net debt of an oil and gas company with the net debt of a consulting firm with little or no capital. As a result, net debt is not a good financial measure when comparing companies in different industries, as companies can have very different borrowing needs and capital structures.


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