Long-Term Debt: What Is It, Importance, Applications & More

Long-term debt is a crucial financial metric for businesses and investors alike. It encompasses all financial obligations that a company expects to repay over a period greater than one year. Long-term debt can include loans, bonds, and other types of credit facilities. 

For companies, it is often a preferred financing method as it provides the capital needed for expansion, acquisitions, or ongoing operations, with the flexibility of repaying it over an extended period.

Companies generally incur long-term debt to finance large investments or capital expenditures, such as purchasing property, machinery, or undertaking long-term projects. 

Unlike short-term debt, which requires quicker repayment, long-term debt allows businesses to manage their finances more effectively while investing in their long-term growth. While short-term debt is expected to be repaid within a year, long-term debt can be repaid over several years or even decades, depending on the terms of the agreement.

Further, long-term debt is used by companies for several strategic reasons:

Financing Growth and Expansion: Businesses use long-term debt to fund major capital expenditures or acquisitions. This allows the company to grow and expand without depleting its existing cash reserves.

Leveraging Low Interest Rates: When interest rates are low, companies may opt for long-term borrowing to lock in favorable rates. This can reduce overall financing costs in the long run.

Tax Benefits: Interest payments on long-term debt are tax-deductible, which reduces the overall tax burden on the company. This makes debt a more attractive option than equity financing in some cases.

Preserving Ownership: Taking on debt allows companies to raise capital without diluting existing shareholders’ equity. Unlike issuing new stock, debt financing does not require the company to give up ownership control.

There are several types of long-term debt instruments, each with specific characteristics and uses. Here are the most common forms:

Bonds: Bonds are debt securities issued by companies or governments that investors purchase. The issuing company promises to pay back the principal amount at a set maturity date and makes regular interest payments, known as coupon payments, over the life of the bond.

Term Loans: These loans are typically provided by banks or other financial institutions and come with a fixed repayment schedule. Term loans are often used for significant investments or business expansion.

Leases: Some companies use long-term lease agreements, such as operating leases or capital leases, to acquire assets without taking ownership. These leases can be structured to extend over multiple years, making them a form of long-term debt.

Convertible Debt: This is a type of loan that can be converted into company equity, often at the discretion of the lender or investor. Convertible debt is commonly used by startups to raise capital without immediately giving up equity.

Long-term debt plays a significant role in various financial ratios that investors use to assess the financial health of a business. Some key ratios include:

The debt-to-equity ratio is a critical metric that compares a company’s total debt (including long-term debt) to its shareholders’ equity. It helps assess the financial leverage of a company and indicates the proportion of debt used to finance assets relative to equity.

D/E = Total Debt / Shareholders’ Equity

A higher ratio may suggest that a company is more leveraged and could face higher risks in periods of financial instability. On the other hand, a lower ratio indicates less reliance on debt for financing.

The interest coverage ratio is used to measure a company’s ability to meet its interest payments on outstanding debt, including long-term debt. It is calculated by dividing the company’s earnings before interest and taxes (EBIT) by the interest expense.

Interest Coverage Ratio = EBIT / Interest Expense

A higher ratio is indicative of a company’s ability to comfortably meet its debt obligations, while a lower ratio could signal potential problems with debt servicing.

Long-term debt is located on the liabilities side of a company’s balance sheet, typically under a section labeled “Long-Term Liabilities.” This section includes obligations that are due for repayment beyond 12 months from the balance sheet date.

1. Non-Current Liabilities Section: Long-term debt is usually listed prominently under non-current liabilities. This category might include bonds payable, notes payable, or loans payable, specifying their amounts and any related terms.
2. Current Portion of Long-Term Debt: A portion of the long-term debt that is due within the next 12 months is often reclassified as a “current liability” under the Current Liabilities section. This allows investors and analysts to separate short-term and long-term obligations.
3. Accompanying Notes to Financial Statements: Details about the long-term debt, such as interest rates, maturity dates, and repayment schedules, are usually disclosed in the notes to the financial statements. These notes provide a deeper understanding of the debt’s terms and conditions.

If a company has a $10 million loan maturing in 5 years, $2 million of the principal due within the next year will be classified as a current liability. The remaining $8 million will appear under long-term liabilities.

This breakdown provides clarity to stakeholders about a company’s financial obligations and how they impact its liquidity and solvency.

Long-term debt is an essential tool in corporate finance, allowing businesses to raise capital for significant investments and growth.

With repayment periods stretching over several years, long-term debt provides companies with the time they need to generate sufficient cash flow to meet their obligations. This stability makes it easier to manage finances during periods of growth.

Long-term debt can often be secured at lower interest rates compared to short-term borrowing, especially if the company has a strong credit rating.

Large-scale projects, such as mergers and acquisitions, often require large sums of money. Long-term debt enables companies to access these large capital amounts without giving up equity.

As mentioned earlier, the interest on long-term debt is tax-deductible. This tax shield can help improve a company’s profitability.

While long-term debt may offer lower interest rates, it still involves significant interest payments that can put a strain on the company’s cash flow. If a business experiences a downturn or is unable to generate sufficient revenue, these payments can become burdensome.

High levels of long-term debt can increase a company’s financial leverage, making it more susceptible to economic downturns or interest rate hikes. This could affect the company’s ability to repay its debts.

If a company fails to manage its debt effectively, it could experience a downgrade in its credit rating. This would increase borrowing costs and reduce access to future financing.

In extreme cases, if a company is unable to meet its long-term debt obligations, it may be forced to file for bankruptcy. This can result in the liquidation of assets and loss of value for shareholders.

InvestingPro offers detailed insights into companies’ Long-Term Debt including sector benchmarks and competitor analysis.

Short-term debt is due within a year, while long-term debt has a repayment period exceeding one year. Long-term debt is often used for capital-intensive investments.

Long-term debt appears as a liability on a company’s balance sheet. It is an important factor in assessing the company’s financial leverage and overall debt profile.

Yes, companies can manage long-term debt effectively if they have stable cash flows and sound financial management. However, excessive debt or poor cash flow management can increase bankruptcy risks.

It depends on the company’s situation. Long-term debt can be cheaper and preserve ownership, but it increases financial risk. Equity financing may be preferred in cases where the company wants to avoid taking on debt or when interest rates are high.