What it means
Debt is usually sorted by how long until it must be repaid. Short-term debt is due within about a year, long-term debt runs for many years, and intermediate-term debt sits between the two, with the exact boundaries varying between lenders and accounting practice.
Companies tend to match the debt to the asset it funds. A delivery firm that buys vehicles lasting five years might take out a five-year loan, so that the repayments end around the time the vehicles need replacing.
This matching principle avoids paying for an asset long after it has worn out. On a balance sheet, only the part of the debt due within twelve months is shown as a current liability.
The remainder stays in non-current liabilities, which is why a single five-year loan appears in two places as it ages. Interest rates on intermediate debt generally sit between short and long rates, though the shape of the yield curve (the pattern of rates across different maturities) can change that ranking.
Lenders often attach covenants, which are conditions the borrower must keep to, such as a minimum cover on interest payments. Pricing also reflects the borrower's credit quality and whether the debt is secured.
A loan backed by equipment or property usually costs less than an unsecured note, because the lender can recover value if repayments stop. The nuance is refinancing risk.
When an intermediate loan matures, the borrower must repay or replace it, and if markets are weak at that moment, the replacement may be costly or hard to arrange.
In practice
Real-world examples.
Example
A restaurant group borrows $750,000 over six years to refit ten locations. The refit will serve customers for about that long, so the lender and the owners agree that repayment should run alongside the benefit.
Example
A software firm issues medium-term notes due in seven years to fund an acquisition. The notes carry a fixed coupon, and the finance team plans to refinance them a year before maturity. Investors accept the seven-year horizon because the acquired business is expected to generate steady cash.
Example
A farming cooperative takes a three-year loan to buy harvesting equipment. Repayments are timed to coincide with sales after each harvest, which keeps the cooperative's cash flow steady. The lender accepts the equipment itself as security, which helps keep the interest rate lower.
Formula
Calculation
Annual interest cost = Principal x Annual interest rate
Total interest over the term (interest-only loan) = Annual interest cost x Number of years
Suppose a company borrows $2,000,000 on a five-year interest-only term loan at 6%. Annual interest is 2,000,000 x 0.06 = $120,000. Over five years the interest totals 120,000 x 5 = $600,000, and the full $2,000,000 is repaid at the end. For balance sheet purposes, at the end of year four the entire $2,000,000 moves into current liabilities because it is due within twelve months.Case study
Seen in the real world.
This is an illustrative story about a fictional business, Cobalt Freight Services, which funded a new fleet of trucks using a five-year term loan. The trucks had a useful life of about eight years, and the loan was repaid in the first five.
In the final year the entire loan balance became a current liability, and the company's current ratio dipped below the lender's covenant level on paper. The finance director had warned the board earlier, and a refinancing was already in progress.
Because credit markets were calm, Cobalt replaced the loan with a new intermediate facility at a similar rate. The new facility was sized slightly smaller, because part of the original balance had been paid down from operating cash flow during the final year. The story is illustrative, and it shows why companies plan refinancing well before maturity and watch how reclassification affects their ratios. The finance director now keeps a maturity calendar showing every facility and the date it turns current, so surprises of this kind are caught at least eighteen months ahead.
Watch out
Common mistakes.
- Treating the whole loan as non-current until it is repaid. Once the repayment date is within twelve months, the balance is reclassified as current.
- Using a fixed definition for the term range. Banks, regulators and analysts draw the line between short, intermediate and long in different places.
- Ignoring refinancing risk. The amount due at maturity can be large, and conditions may be unfavourable when it comes round.
Questions
People also ask.
How long is intermediate-term debt?
It is commonly between one and ten years, though some lenders use narrower ranges such as three to seven years.
Why not just use long-term debt for everything?
Longer debt often costs more in interest and commits the company for longer than the asset may last.
Does it carry a higher rate than short-term debt?
Often, but not always, because the shape of the yield curve and the borrower's credit quality both influence the rate.
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