Long-term debt is a term that comes up again and again in connection with corporate financing . We clarify in this article why long-term debt is of the utmost importance both from an entrepreneurial and a financier’s point of view.
But before we go into their great importance, we first clarify what is actually understood by the term “long-term debt “.
Long-term debt is debt capital available to the company for more than 5 years.
In addition to traditional bank liabilities, bonds and pension provisions are often included.
Therefore, the composition of the long-term debt from the balance sheet is calculated according to the following formula:
Accordingly, long-term debt does not appear on the balance sheet at first glance, as there is no single balance sheet item with the same name.
Instead, it must be developed as a substrate from all the debt. It is first on the liabilities side of the equity from debt to separate. So what is actually real debt or equity on the liability side.
If this is done, only the maturity must be taken into account and the above formula applied.
And you have already developed the long-term debt on the balance sheet.
Provisions can not be viewed per se as long-term debt. The provisions also depend on the maturity. Of course, tax provisions or other provisions, the risk of which could be realized within a very short time, can not be assessed as long-term.
Accordingly, tax provisions and other provisions are classified as current liabilities.
Only the pension provisions, which regularly have a very long residual term, are added to the long-term debt.
balance Sheet analysis
But balance sheet analysis is where long-term debt comes to its true meaning. Because here it is important as part of key figures:
For the calculation of the asset coverage ratios 2 and 3, the long-term debt capital is indispensable as part of the formula. And, as we’ll see later, both ratios are important yardsticks for banks, creditors and entrepreneurs themselves.
Asset coverage ratio 2
The asset coverage ratio 2 is calculated according to the formula
This is already evident in the long-term debt in the meter as part of long-term capital.
After all, according to the golden accounting rule, fixed assets are to be financed by long-term capital.
In this case, it is necessary to remove the short-term capital in the balance sheet in order to be able to make a statement about the long-term nature of the financing of fixed assets.
System coverage 3
Thus, information is provided as to whether fixed assets and inventories are financed by long-term capital.
Further interesting contributions to the determination and analysis of individual key figures can be found on the Controlling Portal.
In the balance sheet analysis , therefore, the true meaning of long-term debt first becomes apparent. As part of the long-term capital, it expresses that part of the debt that remains with the company in the long term and thus enables the entrepreneurial activities from the ground up.
For while short-term debt can be withdrawn from the company almost at any time and therefore already seems to have been withdrawn from medium-term corporate planning, long-term debt remains with the company for more than 5 years.
As a result, long-term debt capital forms the basis of every entrepreneurial activity and, accordingly, of all corporate financing.
There is no real reliable ratio for long-term debt.
Instead, the asset coverage ratio 2 (see above) should be sought as a “golden accounting rule” or “golden banking rule”.
So the entire fixed assets should be financed by equity and long-term debt.
So if there are already large amounts of equity , why should there be a high ratio of long-term debt? If in doubt, this could even be harmful to your income. So the financing structure can also be judged from the outset!
Conclusion meaning long-term debt
As you can see, long-term debt capital only really unfolds its effect in balance sheet analysis .
There, however, it is a determining factor for the analysis of the overall financing structure of a company.
Only when taking into account long-term borrowed capital in the assessment of asset financing does a meaningful picture emerge.
The entrepreneur himself can always keep an eye on whether he can pursue his entrepreneurial activities yet free. Because if these banks are financed only for a short time, he will have to get used to the fact that he is constantly being “fingered” by the financing banks.
Long-term capital consisting of equity (possibly supplemented by mezzanine capital / hybrid capital , subordinated loans ) and supplemented by long-term equity provide entrepreneurial scope – in every respect.
And now to you, dear readers, how do you feel about long-term debt? Has it played a role in your previous financing considerations?