Total debt refers to the sum of borrowed money that your business owes. It’s calculated by adding together your current and long-term liabilities.
Knowing your total debt can help you calculate other important metrics like net debt and debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio, which indicates a company’s ability to pay off its debt. These and other metrics can help you understand the nuances of your business’s finances much better.
Total debt is sometimes confused with net debt, which is a different financial parameter. Net debt is calculated by subtracting the total value of a company’s liquid assets from its total debt. Net debt helps analysts find out if a company has enough liquidity to meet all of its financial obligations and how much of it can be spared for operational purposes.
This article explains what total debt is, why it matters, and how to calculate it. Skip to any section by clicking on one of the below links:
What is total debt?
Total debt is a financial parameter that helps you gain deeper insight into your company’s financial health. In essence, it indicates whether your company is over- or under-leveraged (i.e., whether it’s under a manageable degree of debt). Total debt is an important metric that, when plugged into other formulas, can help analysts figure out important debt-related data.
That being said, total debt isn’t a comprehensive way to judge your finances. Total debt should always be analyzed along with the debt-to-equity ratio, current ratio, and other leverage and liquidity parameters. On its own, total debt can only tell you how much you owe to others.
The importance of total debt
A company’s total debt influences many of its financial decisions. In particular, small and medium-sized businesses need to keep close track of their debt figures to avoid being over-leveraged.
Financial leverage refers to using a debt or loan to purchase assets. While this common business practice can help your company continue and scale up operations without losing equity, high levels of leverage may impact your company’s financial health.
When a company ends up taking on too much debt, its principal and interest payments eat into the operational capital required to keep the company afloat. Closely monitoring your company’s total debt and debt-to-equity ratio can help you avoid this.
Calculating total debt
You can calculate a business’s total debt using the following formula:
The formula elements
To understand the formula better, let’s break down its elements.
Short-term debt
Short-term debt, or short-term liability, refers to the current liabilities you need to pay off within the next 12 months. Short-term debt includes expenses like:
- Accounts payable
- Deferred revenue
- Wages payable
- Short-term notes
Long-term debt
Long-term debt refers to any company loan or payment that isn’t due for at least 12 months. Long-term debt includes:
- Long-term loans
- Capital leases
- Pension liabilities
- Bonds payable
- Deferred income taxes
A practical example of a company’s balance sheet
Balance sheets are brief summaries of all transactions of a similar type conducted within a financial term (usually a quarter). In the balance sheets listed below, total assets (both current and fixed) are listed in blue, whereas all liabilities as well as owner’s equity are listed in red.
The important thing to remember about balance sheets is that the assets must equal total liabilities plus equity. Here’s an example.
Liabilities and Owner’s Equity
11 liabilities to include in total debt calculations
Here are the 11 most common short-term and long-term debts included in a business’s total debt calculation.
Short-term debts
- Short-term notes: Short-term notes are a low-risk financing option issued to businesses needing credit. They accrue monthly interest like a standard loan and typically have less than nine months of original maturities. The lender and borrowing firm typically agree to mutual terms while issuing these notes.
- Accounts payable: Accounts payable is the amount businesses owe to their creditors. It may refer to payments for goods and services that the company purchased but hasn’t yet paid for in full, or it can be something like credit card payments. Generally, the accounts payable amounts are expected to be repaid within the accounting year to avoid credit default.
- Deferred revenue: Deferred revenue refers to the prepayment that a business receives for goods or services that haven’t been delivered to the customer. This is also called unearned revenue or advanced payment and is considered a liability on the balance sheet since the business still owes something to its customers.
- Wages payable: A certain amount of wages is owed to employees for their services. The amount these employees have earned but haven’t yet been paid is referred to as wages payable or accrued wages or compensation.
- Outstanding expenses: An outstanding expense, or an accrued expense, refers to costs recorded before the company has incurred them. These represent future obligations for repayment.
- Taxes payable: Taxes payable refers to the income tax owed by a company to the government. On the other hand, deferred taxes are the difference between the income tax that a company reports from its own accounting records versus the amount owed according to tax laws. The primary source of difference is the way depreciation is accounted for.
Long-term debts
- Bonds payable: The amount owed by a company to the buyers of its bonds is known as the bonds payable. Businesses issue bonds to raise revenue and, in return, assure buyers that they’ll be paid at a later date. Bonds are classified as long-term debts because they typically mature over more than one year.
- Long-term loans: Loans with repayment periods of more than 36 months are considered long-term loans. These can include business loans and deferred income tax.
- Capital leases: Capital leases are contracts that allow borrowers to use an asset temporarily. For accounting purposes, this is categorized as an owned asset for the renting company under the Generally Accepted Accounting Principles (GAAP). However, the lessee doesn’t actually exercise any ownership rights over the leased asset.
- Pension liabilities: At retirement, employees are sometimes owed a pension from the company at which they worked. They’re given this amount either in a lump sum or in smaller installments. Pension liability accounts for these future payments according to the term plans.
- Deferred compensation: Deferred compensation refers to the payments made by a company to its employees at a later date. Employees may opt for deferred compensation because this income is taxed only after the payment is made. Examples include retirement plans or stock option plans.
Need more help tracking business debt?
Given the sheer number of transactions, your business has every day, let alone over a month or a year, keeping track of debt and every other accounting detail is quite a task. Since these details provide critical information and can’t be ignored, it’s often helpful to leave this work to the experts.
At Upwork, you can hire the best independent accountants and financial managers who can create balance sheets, expense reports, and budgets for you. They can handle your financial statements and cash flow statements while you focus on taking your business to the next level.
