Net Debt
What Is Net Debt?
Net debt is a liquidity metric used to determine how well a company can pay its debts in the event that they were all due immediately. Net debt shows the amount of debt a company possesses on its balance sheet compared to its liquid assets.
Net debt shows how much cash would remain in the event that all debts were paid off and assuming a company has enough liquidity to meet its debt obligations.
Net Debt Formula and Calculation
To determine the financial stability of a business, analyst and investors will take a gander at the net debt utilizing the accompanying formula and calculation.
- Total up all short-debt amounts listed on the balance sheet.
- Total all long-term debt listed and add the figure to the total short-term debt.
- Total all endlessly cash equivalents and deduct the result from the total of short-term and long-term debt.
What Net Debt Indicates
All the net debt figure is used as an indication of a business' ability to pay off its debts in the event that they became due simultaneously on the date of calculation, utilizing just its available cash and profoundly liquid assets called cash equivalents.
Net debt helps to determine whether a company is overleveraged or has too much debt given its liquid assets. A negative net debt implies that the company possesses more endlessly cash equivalents than its financial obligations and is hence more financially stable.
A negative net debt means a company has little debt and more cash, while a company with a positive net debt means it has more debt on its balance sheet than liquid assets. However, since it's common for companies to have more debt than cash, investors must compare the net debt of a company with other companies in the same industry.
Net Debt and Total Debt
Net debt is in part, calculated by determining the company's total debt. Total debt includes [long-term liabilities](/longtermliabilities, for example, mortgages and other loans that do not mature for quite some time, as well as short-term obligations, including loan payments, credit cards, and accounts payable balances.
Net Debt and Total Cash
The net debt calculation likewise requires sorting out a company's total cash. Unlike the debt figure, the total cash includes cash and profoundly liquid assets. Endlessly cash equivalents would include items, for example, checking and savings account balances, stocks, and some marketable securities. However, it's important to note that many companies may not include marketable securities as cash equivalents since it depends on the investment vehicle and whether being converted in somewhere around 90 days is liquid enough.
Comprehensive Debt Analysis
While the net debt figure is a great place to begin, a prudent investor must likewise investigate the company's debt level in more detail. Important factors to consider are the genuine debt figures — both short-term and long-term — and which percentage of the total debt needs to be paid off inside the approaching year.
Debt management is important for companies because whenever managed properly they should have access to additional funding if necessary. For some companies, taking on new debt financing is indispensable to their long-growth strategy since the proceeds may be used to fund an expansion project, or to repay or refinance older or more expensive debt.
A company may be in financial distress on the off chance that it has too much debt, yet additionally the maturity of the debt is important to monitor. Assuming the majority of the company's debts are short term, meaning the obligations must be repaid in no less than 12 months, the company must generate enough revenue and have enough liquid assets to cover the impending debt maturities. Investors should consider whether the business could afford to cover its short-term debts assuming that the company's sales decreased altogether.
Then again, on the off chance that the company's current revenue stream is just keeping up with paying its short-term debts and can't adequately pay down long-term debt, it's inevitable before the company will face hardship or will need an injection of cash or financing. Since companies use debt differently and in many forms, it's best to compare a company's net debt to other companies inside the same industry and of comparable size.
Example of Net Debt
Company A has the accompanying financial data listed on its balance sheet. Companies will normally break down whether the debt is short-term or long-term.
- Accounts payable: $100,000
- Credit Line: $50,000
- Term Loan: $200,000
- Cash: $30,000
- Cash equivalents: $20,000
To calculate net debt, we must initially total all debt and total all endlessly cash equivalents. Next, we take away the total cash or liquid assets from the total debt amount.
- Total debt would be calculated by adding the debt amounts or $100,000 + $50,000 + $200,000 = $350,000.
- Endlessly cash equivalents are totaled or $30,000 + $20,000 and equal $50,000 for the period.
- Net debt is calculated by $350,000 - $50,000 equaling $300,000 in net debt.
Net Debt versus Debt-to-Equity
The debt-to-equity (D/E) ratio is a leverage ratio, which shows the amount of a company's financing or capital structure is made up of debt versus giving shares of equity. The debt-to-equity ratio is calculated by dividing a company's total liabilities by its shareholders' equity and is used to determine on the off chance that a company is utilizing too a lot or too little debt or equity to finance its growth.
Net debt takes it to another level by measuring how much total debt is on the balance sheet after factoring in endlessly cash equivalents. Net debt is a liquidity metric while debt-to-equity is a leverage ratio.
Limitations of Using Net Debt
In spite of the fact that it's commonly perceived that companies with negative net debt are better able to withstand economic downtrends and deteriorating macroeconomic conditions, too little debt may be a warning sign. In the event that a company isn't investing in its long-term growth as a result of the lack of debt, it could struggle against competitors that are investing in its long-term growth.
For example, oil and gas companies are capital intensive meaning they must invest in large fixed assets, which include property, plant, and equipment. As a result, companies in the industry normally have huge parts of long-term debt to finance their oil apparatuses and drilling equipment.
An oil company should have a positive net debt figure, yet investors must compare the company's net debt with 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 counseling company with few if any fixed assets. As a result, net debt is definitely not a good financial metric when contrasting companies of different industries since the companies could have immensely different borrowing needs and capital structures.
Features
- Net debt is a liquidity metric used to determine how well a company can pay its debts in the event that they were all due immediately.
- Net debt shows how much cash would remain in the event that all debts were paid off and assuming a company has enough liquidity to meet its debt obligations.
- Net debt is calculated by deducting a company's total endlessly cash equivalents from its total short-term and long-term debt.
FAQ
What Is Net Debt Per Capita?
Net debt per capita is a country-level metric that ganders at a country's total sovereign debt and divides it by the population size. It is used to understand the amount of debt a country possesses with respect to its population considering between-country correlations in understanding a country's relative solvency.
How Do You Calculate Net Debt in Excel?
To calculate net debt utilizing Microsoft Excel, find the accompanying data on the company's balance sheet: total short-term liabilities; total long-term liabilities; and total current assets. Enter these three items into cells A1 through A3, respectively. In cell A4, enter the formula "=A1+A2−A3" to compute net debt.
Which Is More Important: Net Debt or Gross Debt?
Gross debt is the nominal value of the debts as a whole and comparable obligations a company has on its balance sheet. In the event that the difference between net debt and gross debt is large, it indicates a large cash balance along with huge debt, which could be a red flag. Net debt removes endlessly cash equivalents from the amount of debt, which is useful when working out enterprise value (EV) or when a company seeks to make an acquisition. This is because a company isn't interested in that frame of mind to acquire cash. Rather, the net debt will give a better estimate of the takeover value.
