How Net Debt Is Calculated and Why It Matters to a Company

What Is Net Debt?

Net debt is a liquidity metric that's used to determine how well a company can pay all its debts if they come due immediately. Net debt shows how much debt a company has on its balance sheet compared to its liquid assets. It shows how much cash would remain if all debts were paid off and if a company has sufficient liquidity to meet its debt obligations.

Net Debt Formula and Calculation

Analysts and investors will look at the net debt of a company to determine its financial stability. It can be found using this formula and calculation:

$\begin{aligned} &\text{Net Debt} = \text{STD} + \text{LTD} - \text{CCE}\\ &\textbf{where:}\\ &\begin{aligned} \text{STD} = &\text{ Debt that is due in 12 months or less}\\ &\text{ and can include short-term bank}\\ &\text{ loans, accounts payable, and lease}\\ &\text{ payments}\end{aligned}\\ &\begin{aligned} \text{LTD} = &\text{ Long-term debt is debt that with a}\\ &\text{ maturity date longer than one year}\\ &\text{ and include bonds, lease payments,}\\ &\text{ term loans, small and notes payable}\end{aligned}\\ &\begin{aligned} \text{CCE} = &\text{ Cash and liquid instruments that can be}\\ &\text{ easily converted to cash.}\end{aligned}\\ &\text{Cash equivalents are liquid investments with a}\\ &\text{maturity of 90 days or less and include}\\ &\text{certificates of deposit, Treasury bills, and}\\ &\text{commercial paper} \end{aligned}$​Net Debt=STD+LTD−CCEwhere:STD=​ Debt that is due in 12 months or less and can include short-term bank loans, accounts payable, and lease payments​LTD=​ Long-term debt is debt that with a maturity date longer than one year and include bonds, lease payments, term loans, small and notes payable​CCE=​ Cash and liquid instruments that can be easily converted to cash.​Cash equivalents are liquid investments with amaturity of 90 days or less and includecertificates of deposit, Treasury bills, andcommercial paper​

1. Total up all short-debt amounts listed on the balance sheet.
2. Total all long-term debt listed and add the figure to the total short-term debt.
3. Total all cash and cash equivalents and subtract the result from the total of short-term and long-term debt.

What Net Debt Indicates

The net debt figure is used as an indication of a business's ability to pay off all its debts if they became due simultaneously on the date of calculation. It uses only its available cash and highly liquid assets which are referred to as cash equivalents.

Net debt helps to determine whether a company is overleveraged or has too much debt given its liquid assets. A negative net debt implies that the company possesses more cash and cash equivalents than its financial obligations and is therefore more financially stable.

A company has little debt and more cash when it has a negative net debt. A company with a positive net debt means it has more debt on its balance sheet than liquid assets. It's common for companies to have more debt than cash so investors should compare the net debt of a company with other companies in the same industry.

Net Debt and Total Debt

Net debt is calculated in part by determining the company's total debt. This includes long-term liabilities such as mortgages and other loans that don't mature for several years as well as short-term obligations including loan payments, credit cards, and accounts payable balances.

Net Debt and Total Cash

The net debt calculation also requires figuring out a company's total cash. This includes cash and highly liquid assets, unlike the debt figure. Cash and cash equivalents would include items such as checking and savings account balances, stocks, and some marketable securities.

Many companies may not include marketable securities as cash equivalents because it depends on the investment vehicle and whether it's liquid enough to be converted within 90 days.

Comprehensive Debt Analysis

The net debt figure is a great place to start but a prudent investor should also investigate the company's debt level in more detail. Important factors to consider are the actual debt figures, both short-term and long-term, and what percentage of the total debt must be paid off within the coming year.

Debt management is important for companies because they should have access to additional funding if necessary if they handle management properly. Taking on additional debt financing is vital to their long-growth strategy for many companies because the proceeds might be used to fund an expansion project or to repay or refinance older or more expensive debt.

A company might be in financial distress if it has too much debt but the maturity of the debt is also important to monitor. The company must generate enough revenue and have enough liquid assets to cover the upcoming debt maturities if the majority of the company's debts are short-term obligations that must be repaid within 12 months. Investors should consider whether the business could afford to cover its short-term debts if the company's sales decreased significantly.

It's only a matter of time before the company will face hardship or will need an injection of cash or financing if the company's current revenue stream is only keeping up with paying its short-term debts and isn't adequately able to pay down long-term debt. Companies use debt differently and in many forms so it's best to compare a company's net debt to other companies within the same industry and of comparable size.

Example of Net Debt

Company A has the following financial information listed on its balance sheet. Companies will typically break down whether the debt is short-term or long-term.

• Accounts payable: $100,000
• Credit Line: $50,000
• Term Loan: $200,000
• Cash: $30,000
• Cash equivalents: $20,000

We must first total all debt and total all cash and cash equivalents to calculate net debt. Next, we subtract the total cash or liquid assets from the total debt amount.

• Total debt would be calculated by adding the debt amounts or $100,000 + $50,000 + $200,000 = $350,000.
• Cash and cash equivalents are totaled or $30,000 + $20,000 and equal $50,000 for the period.
• Net debt is calculated by $350,000 - $50,000 equaling $300,000 in net debt.

Net Debt vs. Debt-to-Equity

The debt-to-equity (D/E) ratio is a leverage ratio that shows how much of a company's financing or capital structure is made up of debt versus issuing shares of equity. The debt-to-equity ratio is calculated by dividing a company’s total liabilities by its shareholders' equity and is used to determine if a company is using too much or too little debt or equity to finance its growth.

Net debt takes it to another level by measuring how much total debt is on the balance sheet after factoring in cash and cash equivalents. Net debt is a liquidity metric. Debt-to-equity is a leverage ratio.

Limitations of Using Net Debt

It's typically perceived that companies with negative net debt are better able to withstand economic downtrends and deteriorating macroeconomic conditions but too little debt can be a warning sign. A company might struggle against competitors that are investing in long-term growth if it's not doing the same.

Oil and gas companies are capital-intensive. They must invest in large fixed assets that include property, plants, and equipment. Companies in the industry typically have significant portions of long-term debt as a result of financing their oil rigs and drilling equipment.

An oil company should have a positive net debt figure but investors must compare the company's net debt with other oil companies in the same industry. It doesn't make sense to compare the net debt of an oil and gas company with the net debt of a consulting company with few if any fixed assets. Net debt isn't a good financial metric when comparing companies of different industries because the companies might have vastly different borrowing needs and capital structures.

Which Is More Important: Net Debt or Gross Debt?

Gross debt is the nominal value of all of the debts and similar obligations a company has on its balance sheet. It indicates a large cash balance along with significant debt if the difference between net debt and gross debt is large. This could be a red flag.

Net debt removes cash and cash equivalents from the amount of debt and this can be useful when calculating enterprise value (EV) or when a company wants to make an acquisition. The company isn't interested in spending cash to acquire cash. The net debt will give a better estimate of the takeover value.

How Do You Calculate Net Debt in Excel?

Find the following information on the company's balance sheet to calculate net debt using Microsoft Excel: total short-term liabilities, total long-term liabilities, and total current assets. Enter these three items into cells A1 through A3 respectively. Enter the formula "=A1+A2−A3" in cell A4 to compute net debt.

What Is Net Debt Per Capita?

Net debt per capita is a country-level metric that looks at a nation's total sovereign debt and divides it by its population size. It's used to understand how much debt a country has in proportion to its population allowing for between-country comparisons.

The Bottom Line

The net debt metric measures liquidity. It reveals the extent to which a company can pay its debts if they were all to come due immediately and at the same time. How much in the way of cash and highly liquid assets, if any, would remain after it did so?

A financially stable company should have negative net debt but having too little debt can be a warning sign as well. It can indicate that the company isn't investing in long-term growth.

A similar measurement calculates what percentage of a company’s debt must be paid off within a year. Using both in tandem can be helpful when you're evaluating a company.