What is Debt Really?

Take a look at your company’s balance sheet and see if you identify everything that is debt. Is there anything hidden?

A Simple Example

Let’s consider the balance sheet below and see if we can form some conclusions.

what is debt

When we look at this balance sheet we could come to several conclusions. One, we might consider debt to be only the non-current debt of $400,000. Another option is to consider both the Current and L.T. Portion of L.T. Debt for a total of $500,000. But let me ask you something. Is the company indebted for the Accounts Payable, Sales Tax Payable, Income Tax Payable, and Accrued Expenses as well? The bottom line is, yes. But, when we talk about debt we are generally referring to debt that is financed, so in this case it is the Current and L.T. Portion of L.T. Debt totaling $500,000. For example, the $500,000 in debt may have been used to finance the purchase of the $700,000 of Fixed Assets. The other liabilities are obligations but fall into the category of operating obligations as opposed to financing

Regardless, I encourage you to include those other obligations when you think about how much your company owes, even if it is not included in the formal amount considered as debt.

What Else Could There Be

You have probably heard the term “Off Balance Sheet”. Imagine in the example above that the company also leases its building and it is classified as an operating lease. In that case it is not on the balance sheet. There are proposals to change the way obligations of this nature are classified and recorded, but those had not been finalized when I was writing this. At any rate, imagine that the building lease is for 5 years at $20,000 per year. That represents a $20,000 obligation for the next year and $80,000 over the remaining 4 years. Unless there is a way to break the lease, that $100,000 of lease payments is really just as much a debt as anything else, even though it is not being reflected on the balance sheet. Again, this is something you should consider when you think about your company’s total indebtedness.

Are you clear on what you are really indebted for, even if it is not formally considered debt for accounting purposes?

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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