What it means
The twelve month line is the only thing separating long-term debt from short-term debt, and it moves every reporting period. A five year loan taken today is long-term, but the instalments due in the next twelve months are stripped out and shown as the current portion of long-term debt.
As the loan matures, more of it slides across into current liabilities. Long-term debt is generally the cheaper and calmer way to fund assets that will earn money for years.
Matching a fifteen year mortgage to a building, rather than funding it on an overdraft, lines the repayment schedule up with the cash the asset actually generates. The cost is not only the interest rate.
Long-term lenders attach covenants, which are promises the borrower makes about leverage, interest cover or minimum asset values. Breaking one can make the entire balance repayable immediately, which is how a whole loan can jump into current liabilities overnight.
Interest on long-term debt is usually tax deductible, which lowers its effective cost relative to equity funding. That advantage is real but limited, because heavy borrowing raises the risk of financial distress and makes future funding dearer.
When reading accounts, look at the maturity table in the notes rather than the single balance sheet figure. It shows how much falls due in each of the next five years, and a large repayment clustered in one year is a refinancing risk worth flagging early.
In practice
Real-world examples.
Example
A hotel group borrows $12,000,000 over twenty years to buy a freehold property. The loan is long-term debt except for the $600,000 of principal repayments scheduled in the coming year, which appear in current liabilities.
Example
A manufacturer issues $50,000,000 of ten year bonds to refinance shorter bank facilities. The whole amount sits in long-term debt until the final year, when it moves into current liabilities and the refinancing question becomes urgent.
Example
A haulage company signs finance leases on twenty vehicles over five years. Accounting rules require the lease obligations to be shown as debt, so the balance sheet suddenly carries several million dollars of long-term debt that the old rules would have kept off it.
Formula
Calculation
Long-Term Debt = Total Borrowings - Current Portion Due Within Twelve Months
A regional distributor has total borrowings of $8,000,000 at its year end: a $6,000,000 property mortgage, a $1,500,000 equipment loan and a $500,000 vehicle finance facility. Repayments falling due in the next twelve months come to $1,200,000.
Total borrowings = $6,000,000 + $1,500,000 + $500,000 = $8,000,000
Current portion of long-term debt = $1,200,000
Long-term debt = $8,000,000 - $1,200,000 = $6,800,000
With shareholders' equity of $17,000,000, the long-term debt to equity ratio is $6,800,000 / $17,000,000 = 0.40. For every dollar of equity the business carries 40 cents of long-term borrowing, which most lenders would regard as comfortable.
If the distributor repays an extra $800,000 during the following year without new borrowing, long-term debt falls to $6,000,000 and the ratio becomes $6,000,000 / $17,000,000 = 0.35.Case study
Seen in the real world.
Brookmere Dairy is an invented company used here to illustrate how long-term debt is managed rather than merely recorded. It had funded a new processing plant with a $6,000,000 seven year loan and a $2,000,000 five year equipment facility, and the balance sheet showed $6,800,000 of long-term debt against $1,200,000 in current liabilities.
The problem was hidden in the maturity table. Both facilities carried bullet repayments in the same year, meaning $3,400,000 fell due within a single twelve month window four years out. In this illustrative case nobody had noticed, because the headline long-term debt figure looked perfectly reasonable.
Brookmere refinanced the equipment facility early, extending it by two years so the two large repayments no longer landed together. The total borrowing was unchanged and the interest cost rose slightly, but the fictional finance director judged that removing a single point of refinancing risk was worth a few thousand dollars a year.
Watch out
Common mistakes.
- Reading the long-term debt line as the total the company owes. The current portion sits elsewhere on the balance sheet, so total borrowings are always higher than the long-term figure alone.
- Assuming long-term debt is safer simply because it is due later. A covenant breach can make the whole balance repayable on demand, regardless of the stated maturity.
- Ignoring finance leases. Under current accounting rules most leases sit on the balance sheet as debt, and leaving them out understates leverage significantly.
Questions
People also ask.
What counts as long-term debt?
Any borrowing whose repayment falls more than twelve months after the balance sheet date, including term loans, mortgages, bonds and lease liabilities.
Is more long-term debt always bad?
No, borrowing to fund assets that generate reliable cash can raise returns to shareholders, provided the interest and repayments are comfortably covered.
Where do I find the repayment schedule?
In the notes to the accounts, where a maturity table sets out how much falls due in each of the next several years.
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