What is a 'Funded Debt'

A funded debt is a company's debt that will mature in more than one year or one business cycle. This type of debt is classified as funded debt because it is funded by interest payments made by the borrowing firm over the term of the loan.

Funded debt is synonymous with long-term debt.

BREAKING DOWN 'Funded Debt'

When a company takes out a loan, it does so either by issuing debt in the open market or securing financing with a lending institution. Loans are categorized as unfunded or funded, and are taken out by a company to finance its long-term capital projects, such as the addition of a new product line or the expansion of operations. Unfunded debt are short-term financial obligations that are due in a year or less. Examples of short-term liabilities include corporate bonds that mature in one year and short-term bank loans. A firm may use short-term financing to fund its long-term operations. This exposes the firm to a higher degree of interest rate and refinancing risk, but allows for more flexibility in its financing.

Funded debt refers to any financial obligation that extends beyond a 12-month period, or beyond the current business year or operating cycle. It is the technical term applied to the portion of a company's long-term debt that is made up of long-term, fixed-maturity types of borrowings. Examples of funded debt include bonds with maturity dates of more than a year, convertible bonds, long-term notes payables, and debentures. Funded debt is sometimes calculated as long-term liabilities minus shareholders’ equity.

Funded debt is an interest-bearing security that is recognized on a company’s balance sheet statement. A debt that is funded means that it is usually accompanied by interest payments which serve as interest income to the lenders. From the investor's perspective, the greater the percentage of funded debt to total debt disclosed in the debt note in the notes to financial statements, the better.

Analysts and investors use the capitalization ratio, or cap ratio, to compare a company’s funded debt to its capitalization or capital structure. The capitalization ratio is calculated by dividing long-term debt by the total capitalization, which is the sum of long-term debt and shareholders’ equity. Companies with a high capitalization ratio are faced with the risk of insolvency if their debt is not repaid on time, hence, these companies are considered to be risky investments. However, a high capitalization ratio is not necessarily a bad signal, given that there are tax advantages associated with borrowing. Since the ratio focuses on financial leverage used by a company, how high or low the cap ratio is depends on the industry, business line, and business cycle of a company.  

Another ratio that incorporates funded debt is the funded debt to net working capital ratio. Analysts use this ratio to determine whether or not long-term debts are in proper proportion to capital. A ratio of less than 1 is ideal; in other words, long term debts should not exceed the net working capital. However, what is considered an ideal funded debt to net working capital ratio may vary across industries.

 

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