Debt represents borrowed money that a company must repay, usually with interest, by a specified date. It can be a crucial source of funding for operations, expansion, or acquisitions, but it also carries an obligation for repayment, making it a liability on a company's balance sheet.

Formula

For a general understanding of a company's total debt, it is typically derived directly from the balance sheet by summing all interest-bearing liabilities. Total Debt = Short-Term Debt + Long-Term Debt. Short-Term Debt refers to obligations due within one year, such as current portions of long-term debt, lines of credit, or short-term notes payable. Long-Term Debt refers to obligations due in more than one year, such as bonds payable, long-term notes payable, and capital lease obligations.

Why is it Important for Investors?

Investors closely monitor a company's debt levels because they reveal significant insights into its financial risk and leverage. High debt can indicate that a company relies heavily on borrowed funds, potentially increasing its financial vulnerability during economic downturns or if interest rates rise, making it harder to service its obligations. Conversely, well-managed debt can be a powerful tool for growth, allowing a company to finance strategic initiatives without diluting shareholder equity. The ability to service debt is critical, and excessive debt can lead to bankruptcy if a company cannot meet its repayment schedule.

What is a Good Debt?

What constitutes "high" or "low" debt is highly dependent on the industry. Capital-intensive industries like utilities, telecommunications, and manufacturing often carry higher debt levels due to the significant investments required for infrastructure and equipment. In these sectors, a debt-to-equity ratio of 1.0 or higher might be common and manageable. Conversely, technology or service-based companies, which typically have lower capital expenditure needs, are generally expected to maintain lower debt levels; a debt-to-equity ratio significantly above 0.5 might be considered high. It's crucial to compare a company's debt metrics against its industry peers and historical trends, alongside its cash flow generation and interest coverage ratios, to assess its financial health effectively.