LongTerm Debt and Notes Payable

1
Long-Term Debt and Notes Payable
Matthew Mitchell
October 29, 2002
2
Definition of Debt
A notes payable is a written obligation
specifying the amount to be borrowed, when it
must be repaid, and the interest rate.
Provided by financial institutions such as
commercial banks, insurance companies, pension
plans, and the public.
Used by companies to finance ongoing and future
operations.
Expected that the investment of the borrowed
funds by the company in its operations will
produce returns that exceed the interest rate it
is paying to use the money.
3
Importance of Debt to Analysts
Predictor of future obligations to its creditors.
Shows how effectively management is leveraging
the companys assets to produce growth.
Indicator of how creditors view the companys
ability to produce future cash flow.
Basis of estimates for companys current and
future liquidity.
4
Location on Financial Statements
Debt due within one year listed under current
liabilities.
Debt due in more than one year listed under
long-term liabilities.
New debt financing or repayments listed under
financing cash flows.
Explanation of debt recorded on financial
statements in notes to financial statements.
5
Effects on Financial Statements
Companies may use debt financing to bolster their
cash position to hide loss of cash from
operations.
The companys current liquidity may last only for
the duration of the debt, rather than being
sustainable.
Compare current level of cash and trend in free
cash flow with its long-term debt to determine
its liquidity.
Check large increases in long-term debt against
the activities the company is using it to finance.
6
Debt Schedule
Financial statement notes list schedule of
interest and principal payments for a companys
debt.
Used to determine if a company will be able to
meet its future debt payments (i.e. future
solvency)
Tells when a company may need to secure
additional financing or make an equity offering.
Interest rate company is paying shows the risk
with which financial institutions view it.
7
Composition of Financing
Existence of commercial paper as part of debt may
indicate that the company has solid credit.
Sole financing by equity offerings, especially
among younger companies, indicates high risk in
the company.
Compare mix of debt to equity using the debt /
equity ratio to determine if company is over or
under leveraged.
S P and Moodys credit ratings are indicators
of companys future prospects.