What It Is:
How It Works/Example:
Let's assume Company XYZ borrowed $12 million from the bank and now must repay $100,000 of the loan every month for the next 10 years. Here is Company XYZ's balance sheet before borrowing the $12 million:
Note that $1.2 million (12 months x $100,000 principal repayment) of the $12 million is classified as a current liability, because this amount is due within one year. The remaining $10,800,000 ($12,000,000 - $1,200,000) is classified as long-term debt.
A company's long-term debts are ranked on the balance sheet in the order they will be repaid if the company is liquidated. A company must record the market value of its long-term debt on the balance sheet, which is the amount necessary to pay off the debt as of the date of the balance sheet.
Don't confuse long-term debt with total debt, which includes debt due in less than one year.
Why It Matters:
Analysts evaluate a company's long-term debt to see how much leverage a company has and how solvent the company is. In general, long-term debt can help a company magnify its financial success, but the burden of principal and interest payments may become too heavy for companies that borrow excessively.
Interest rate changes can motivate companies to repay long-term debt before it is actually due. If a company notices that interest rates have fallen below the rate the company is currently paying on its debt, the company may choose to pay off the high-rate debt with new, lower-rate debt.
It is important to read the notes to financial statements when studying a company's long-term debt. Debt terms and requirements vary widely from company to company. Comparison of long-term debt amounts is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" amount of debt should be made within this context.