What is Long-Term Debt
Long-term debt consists of loans and financial obligations lasting over one year. Long-term debt for a company would include any financing or leasing obligations that are to come due after a 12-month period. Long-term debt also applies to governments as nations can also have long-term debt.
In the U.K., long-term debts are known as long-term loans.
BREAKING DOWN Long-Term Debt
Financial and leasing obligations, also called long-term liabilities, or fixed liabilities, would include company bond issues or long-term leases that have been capitalized on a firm's balance sheet. Often, a portion of these long-term liabilities must be paid within the year; these are categorized as current liabilities, and are also documented on the balance sheet. The balance sheet can be used to track a company's debt and profitability.
On a balance sheet, companies' debts are categorized as either financial liabilities or operating liabilities. Financial liabilities refer to debts owed to investors or stockholders; these include bonds and notes payable. Operating liabilities refer to the leases or unsettled payments incurred in order to maintain facilities and services for the company. These include everything from rented building spaces and equipment to employee pension plans.
Bonds are one of the most common types of long-term debt. Companies may issue bonds to raise funds for a variety of reasons, such as to raise capital for new capital projects. Bond sales bring in immediate income, but the company ends up paying for the use of investors' capital due to interest payments.
Why Incur Long-Term Debt?
A company takes on long-term debt in order to acquire immediate capital. For example, startup ventures require substantial funds to get off the ground and pay for basic expenses, such as research expenses, insurance, license and permit fees, equipment and supplies, and advertising and promotion. All businesses need to generate income, and long-term debt is an effective way to get immediate funds to finance business operations.
Aside from need, there are many factors that go into a company's decision to take on more or less long-term debt. During the Great Recession, many companies learned the dangers of relying too heavily on long-term debt. In addition, stricter regulations have been imposed to prevent businesses from falling victim to economic volatility. This trend affected not only businesses, but also individuals, such as homeowners.
Long-Term Debt: Helpful or Harmful?
Since debt sums tend to be large, these loans take many years to pay off. Companies with too much long-term debt will find it hard to pay off these debts and continue to thrive, since much of their capital is devoted to interest payments, making it difficult to allocate money to other areas. A company can determine whether it has accrued too much long-term debt by examining its debt-to-equity ratio.
A high debt-to-equity ratio means the company is funding most of its ventures with debt. If this ratio is too high, the company is at risk of bankruptcy if it becomes unable to finance its debt due to decreased income or cash flow problems. A high debt-to-equity ratio also tends to put a company at a disadvantage against its competitors who may have more cash. Many industries discourage companies from taking on too much long-term debt in order to reduce the risks and costs closely associated with unstable forms of income. Also, regulations are in place that restrict the amount of long-term debt a company can acquire.
For example, since the Great Recession, banks have begun to scrutinize companies' balance sheets more closely, and a high level of debt can prevent a company from getting further debt financing. Consequently, many companies are adapting to this rule to avoid being penalized, such as taking steps to reduce their long-term debt and rely more heavily on stable sources of income.
A low debt to equity ratio is a sign that the company is growing or thriving, as it is no longer relying on its debt and is making payments to lower it. It consequently has more leverage with other companies and a better position in the current financial environment. However, the company must also compare its ratio to those of its competitors, as this context helps determines economic leverage.
For example, Adobe Systems Inc. reported a higher amount of $2.52 billion long-term debt in the fiscal period ended September 2017 than it had in the previous seven years. This debt is still low compared to many of its competitors, such as Microsoft Corp. ($107.84 billion) and Apple Inc. ($140.46 billion), so Adobe retains relatively the same place in the market. However, comparisons fluctuate with competitors such as Symantec Corp. ($9.17 billion) and Quintiles Transnational ($12.09 billion) who carry a similar amount of long-term debt as Adobe.
A company's long-term debt may also put bond investors at risk in an illiquid bond market. The question of the liquidity of the bond market has become an issue since the Great Recession, as banks that used to make markets for bond traders have been constrained by greater regulatory oversight.
Long-term debt is not all bad, though, and in moderation, it is necessary for any company. Think of it as a credit card for a business: in the short-term, it allows the company to invest in the tools it needs to advance and thrive while it is still young, with the goal of paying off the debt when the company is established and in the financial position to do so. Without incurring long-term debt, most companies would never get off the ground. Long-term debt is a given variable for any company, but how much debt is acquired plays a large role in the company's image and its future.
Bank loans and financing agreements, in addition to bonds and notes that have maturities greater than one year, would be considered long-term debt. Other securities such as repos and commercial papers would not be long-term debt, because their maturities are typically shorter than one year.