How it works (Example):
The formula for net debt is:
For example, let's assume that Company XYZ has $10,000,000 in short-term debt, $4,000,000 in long-term debt, and $1,000,000 in cash and cash equivalents. According to the formula, Company XYZ's net debt is:
Net Debt = $10,000,000 + $4,000,000 - $1,000,000 = $13,000,000
Why it Matters:
Net debt is a measure of a company's ability to repay its debts if they were all due today. Thus, it helps analysts and investors get a better feel for whether a company is over- or underleveraged -- that is, whether a company can "afford" its debt. Companies with large amounts of debt but also large cash positions are generally in better positions to weather adverse changes in the economic landscape, like interest rate fluctuations, recessions, etc.
To learn more about evaluating companies' debt loads, click here to read, The One Key Financial Statistic You Must Know.