Long-Term Debt
Long-term debt, also known as non-current liabilities, refers to any financial obligation that is due more than one year from the date of the balance sheet. It represents money that a company has borrowed and must repay in the future, but not within the next year.
Examples of long-term debt might include:
- Bonds Payable: If a company issues bonds to investors, they are essentially borrowing money that they promise to repay at a certain date in the future, typically more than a year out. The company will make regular interest payments to the bondholders until the maturity date, when it will repay the principal amount of the bond.
- Notes Payable: These are formal loan agreements, often with a bank, that have a repayment period of more than one year.
- Mortgages: If a company borrows money to purchase property or buildings and the loan is scheduled to be repaid over a period of more than one year, this would be considered long-term debt.
- Lease Obligations: If a company has lease agreements that are classified as finance leases (or capital leases under older accounting standards), the present value of the future lease payments is recorded as a liability on the balance sheet.
- Pension Liabilities: If a company promises to pay its employees certain benefits upon retirement, it may have a long-term liability to fund these future pension payments.
Long-term debt is recorded on the company’s balance sheet and is important for both the company’s management and investors. It can be an effective way for a company to raise money for major purchases or investments that the company believes will generate enough income or value to offset the cost of the debt. However, too much long-term debt can be risky, especially if the company runs into financial trouble and struggles to keep up with its debt payments. Investors and analysts often look at a company’s debt levels relative to its income or equity when assessing the company’s financial health.
Example of Long-Term Debt
Let’s look at a hypothetical example of a manufacturing company, “ManuCorp,” and how it might use long-term debt.
ManuCorp decides to expand its operations by building a new factory. The cost of the land, construction, and new equipment is estimated to be $10 million, an amount that ManuCorp doesn’t have readily available in cash.
So, ManuCorp decides to raise the needed funds by issuing bonds. It sells $10 million worth of bonds with a maturity date 10 years into the future. The bonds carry an annual interest rate of 5%, which means ManuCorp will need to pay $500,000 per year in interest to the bondholders.
In this case, the $10 million it has borrowed by issuing bonds is considered long-term debt and is recorded on ManuCorp’s balance sheet. The yearly interest payments of $500,000 are recorded as interest expense in ManuCorp’s income statement.
Each year, ManuCorp will also reduce its long-term debt on the balance sheet as it sets aside money (usually in a sinking fund) to repay the bondholders at the end of the 10 years. But if it’s within a year of the bond’s maturity date, the portion due within a year would be considered a current liability, not long-term debt.
This example shows how long-term debt can help a company finance large projects that it wouldn’t otherwise be able to afford. However, it also introduces obligations for regular interest payments and repayment of the principal amount at the maturity date, which the company must manage effectively.
