Long-Term Debt: Definition, Formula & Example Guide
Many businesses use debt in a wide range of ways.
While debt is often seen as a bad thing, it can actually help a company fuel growth, help them expand, and benefit their long-term future and stability.
One of the main types of debt is long-term debt.
But what exactly is long-term debt? And can it be profitable?
Read on as we take a closer look at everything you’ll need to know about this type of debt.
Table of Contents
- Debt with a maturity date of more than a year is referred to as long-term debt and is frequently handled differently compared to short-term debt.
- Long-term debt is an obligation for the issuer to pay back, but it is an asset for the holders of the debt (such as bondholders).
- Business solvency ratios are examined by stakeholders and rating agencies. This is to determine solvency risk and include long-term debt liabilities as a crucial component.
What Is Long-Term Debt?
Long-term debt (LTD) is debt with a maturity date of more than a single year. The issuer’s financial statement reporting and financial investing are the two ways that you can use to look at long-term debt. Companies must mention the issuance of long-term debt together with all related payment obligations in their financial accounts. On the other hand, buying long-term debt involves investing in debt securities having maturities longer than a year.
What Is Long-Term Debt on a Balance Sheet?
On the balance sheet, long-term debt is categorized as a non-current liability. This basically means that it won’t be paid off for at least a year. Long-term debt (LTD) accounts may be split up into individual items or consolidated into one line item that includes several sorts of debt.
The value of the LTD will migrate to the current liabilities area of the balance sheet. This is when all or a portion of it becomes due within a year, which is commonly referred to as the current portion of the long-term debt.
Types of Long-Term Debt
The term long-term debt is an all-in-one phrase that refers to a wide variety of loans. The most typical instances of the many types of long-term debt are provided below:
Any loan granted by a bank or other financial organization falls under this category. Unlike bonds, a bank loan cannot be traded or transferred.
These are loans that are secured by a particular real estate asset, such as a piece of land or a structure.
Municipal bonds are instruments of debt security issued by government organizations. This is to finance infrastructure projects. Municipal bonds are often regarded as one of the least risky bond investments on the debt market. This is because they only have a little more risk than Treasury securities. For public investment, government organizations may issue either short- or long-term debt.
These are loans that lack a specified asset as collateral and have a lower priority for repayment than other types of debt.
The U.S. Treasury is one of the many governments that issue both short- and long-term debt securities. Long-term Treasury securities are issued by the U.S. Treasury and have maturities of two, three, five, seven, ten, twenty, and thirty years.
One popular form of long-term debt investing is corporate bonds. Compared to Treasury and municipal bonds, corporate bonds are more susceptible to default. Corporations, like governments and municipalities, are given ratings by rating agencies. This makes their risks transparent. When evaluating and assigning entity ratings, rating agencies place a strong emphasis on solvency ratios. Different maturities of debt can be issued by corporations. Long-term debt investments are all corporate bonds with maturities longer than one year.
What Kind of Debts Make up Long-Term Debt?
Long-term debt can include liabilities like mortgages on business properties or real estate, commercial bank business loans, and corporate bonds issued with investment bank support to fixed income investors who rely on the interest income. Long-term debt is frequently used by company leaders and the board of directors for a variety of purposes, including but not limited to:
- Stock buybacks: Buying back shares to increase the ownership percentage of the company on the remaining shares.
- Capital: Taking advantage of low-interest rate environments where it is possible to raise a lot of cash relatively cheaply, possibly below the long-term inflation rate if income tax deductions are taken into account, then saving it up for future use.
- Possibility: Investing in expansion and acquisitions without dilution of the investor’s capital.
Can Long-Term Debt Be Profitable?
Yes, although it may seem strange, it can be profitable to have long-term debt.
It is beneficial for a firm to borrow money if it can generate a better rate of return on capital than the interest costs associated with borrowing that capital. Even though it may not always be prudent, especially when there is a chance of an asset/liability mismatch, it does mean that it can boost earnings by raising the return on equity.
The tricky part is for management to understand how much debt goes beyond the bounds of responsible stewardship.
Long-term debt is a catch-all term that is used to describe a wide range of different types of debt and long-term liability. Businesses can use these debts to achieve a variety of things that will help to secure their financial future and grow their long-term expansion.
It’s important to note that while debt can be beneficial, taking on too much debt can harm a company. Any form of debt creates financial leverage for businesses, raising both the risk and the anticipated return on the company’s equity capital.
Frequently Asked Questions
Examples of long-term debt include bank debt, mortgages, bonds, and debentures.
Companies frequently employ long-term debt to finance long-term expenditures like the purchase of equipment or fixed assets because they have a tendency to match the maturity of their assets and liabilities. Long-term financing also protects against changes in the credit supply and the need to refinance during difficult times.
The most sensible course of action a business can take to lower its debt-to-capital ratio and reduce its debt burden is to boost sales revenues and, ideally, profits. This can be accomplished by increasing costs, boosting sales, or raising pricing. The additional funds can then be utilized to settle the outstanding debt.
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