What Is Debt Load?
Debt load is the total amount of debt carried by an individual, government, or business. Publicly traded companies record their debt load on their balance sheets, providing investors with a snapshot of what they own and owe every quarter.
- Debt load is the total amount of debt carried by an individual, government, or business.
- Publicly traded companies record their debt load on their balance sheets, providing investors with a snapshot of what they own and owe every quarter.
- A sensible debt load depends on the size of the company and its industry.
- Various metrics can be used to determine if the level of debt on a company’s books is within a healthy range.
Understanding Debt Load
Just like regular individuals, companies use debt to make large purchases that they could not otherwise afford under normal circumstances. Corporations can usually borrow money by either taking out a loan at a bank or lending institution or by issuing fixed-income (debt) securities such as bonds and commercial paper.
The best way to think about the debt load a company is carrying is in relation to its assets or equity. In absolute terms, a large company is likely to be carrying a large amount of debt. But relative to its assets or equity, the debt may be small.
Different industries have different needs, too. Some companies are more capital-intensive, requiring large amounts of money to produce goods or services. In other words, that means the "right" amount of debt, or leverage, can vary from business to business.
A sensible debt load depends on the size of the company and its industry: some sectors require greater financial resources to operate than others.
Advantages and Disadvantages of Debt Load
Debt tends to have negative connotations. Companies with hefty financial liabilities risk going bankrupt if business dries up, sales drop and they fail to make interest payments.
For that reason, investors are advised to closely scrutinize balance sheets. It’s important to assess if the company has sufficient cash flows and diversified enough operations to meet obligations should it get into trouble and experience a couple of big setbacks. It’s also wise to check if any of its borrowings contain provisions for potential early repayment.
Investors should not forget either that debt, when managed correctly, can be positive. A company that’s debt-free may be missing out on important expansion opportunities and not running at its full potential.
Moreover, debt often presents the only viable option for a company to raise capital without selling shares of company stock and ceding control and ownership. Another advantage to bear in mind is that the principal and interest payments on borrowings can be deducted from taxes as expenses.
Methods to Measure Debt Load
There are a wide range of ratios out there to help determine whether a company's debt load is too large. They include:
The simplest of these divides a company's total debt by the total assets. A low debt ratio is usually a sign of a healthy company. But what is considered low? That depends on the size of the company and its industry. To determine whether a company's debt load is too large or about right, compare it with similarly sized companies in the same sector.
Debt to Equity Ratio
Another useful ratio is the debt to equity ratio. To calculate this, divide the total debt by the total equity. Again, whether this figure is too large or about right depends on the size of the company and the industry.
The Debt To Equity Ratio
Debt Service Coverage Ratio
A company's debt load may also be assessed in relation to its income. The debt service coverage ratio compares a company's operating income—profit generated from normal business operations—to its debt payments.
Interest Coverage Ratio
The interest coverage ratio determines how easily a company can pay interest on its outstanding debt by dividing its earnings before interest and taxes (EBIT) during a given period by interest payments due within the same timeframe.