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Key Takeaways
- Total debt is the money your business owes to others, be it creditors, suppliers, or stakeholders. It includes short-term debts and long-term debts.
- Calculating and managing total debt helps manage cash flow, creditworthiness, and financial risk of the company.
- Total debt is often mistaken for net debt, but they are different financial measures. Net debt is determined by subtracting a company’s total liquid assets from its total debt.
Introduction
Running a business is challenging. One essential part of succeeding is creating a sound financial strategy. Managing debt is a crucial component of an effective financial strategy.
Understanding your business’s total debt is crucial for maintaining healthy cash flow and making informed decisions. If you’re unsure about what is included in total debt or how to calculate it, this confusion can lead to financial missteps and hurt your business.
To make it easier for you, in this blog, we’ll break down what total debt is, how to find it, and the formula to calculate it. By the end, you’ll have a clear understanding of what total debt is, how to calculate it, and how to manage it effectively. Let’s get to it.
What Is Total Debt?
Total debt represents the sum of all financial obligations your business owes to external parties. It encompasses short-term debts, due within a year, and long-term debts, payable after one year. Understanding your total debt is crucial for assessing your business’s financial health.
Think of your business like a household. Just as you might have monthly bills (short-term debts) and a mortgage or car loan (long-term debts), your business has similar financial obligations. Managing both types of debt effectively ensures your business stays financially stable, just like keeping up with household expenses keeps your home running smoothly.
What Is Included in Total Debt?
Total debt includes all the financial obligations your business owes to others, both short-term and long-term. In this case, short-term debt are the ones that last for a year where as long-term debts have a payment timeline of more than a year. The sum of both these debts gives the total debt.
Short-Term Debt: These are debts that need to be paid within a year. They include:
- Bank Overdrafts: Money borrowed from the bank that needs to be repaid quickly.
- Short-Term Loans: Loans that are due within a year.
- Accounts Payable: Bills from suppliers that you need to pay soon.
- Current Portion of Long-Term Debt: The part of long-term loans that you need to pay off this year.
Long-Term Debt: These are debts that are due after a year. They include:
- Long-Term Loans: Loans that you repay over several years.
- Bonds Payable: Money borrowed through bonds that will be repaid in the future.
- Mortgages: Loans taken to buy a property, paid off over several years.
By understanding what’s included in total debt, you can better manage your business’s financial obligations and keep your finances in check.
Why Is it Crucial to Understand Your Total Debt
Understanding and managing total debt is crucial for every business. Here’s why:
1. Financial health assessment
Knowing your total debt helps you gauge your business’s financial stability. It gives you a clear picture of how much you owe and to whom, allowing you to make informed decisions about spending, saving, and investing.
2. Cash flow management
Total debt impacts your cash flow. By keeping track of your debts, you can plan your payments better, ensuring you have enough cash on hand to meet daily operational needs without getting caught off guard by large, unexpected payments.
3. Risk management
High levels of debt can indicate higher financial risk. Understanding your total debt allows you to identify potential financial strains early and take corrective measures to mitigate risks, such as renegotiating payment terms or prioritizing debt repayment.
4. Creditworthiness
Lenders and investors look at your total debt to assess your creditworthiness. A well-managed debt profile can improve your chances of securing loans or attracting investment, as it shows that your business is capable of handling its financial obligations responsibly.
5. Strategic planning
Knowing your total debt helps in strategic business planning. Whether it’s planning for expansion, new investments, or debt repayment strategies, a clear understanding of your debt allows you to make better long-term decisions.
By monitoring your total debt, you can maintain a healthy balance sheet, enhance your financial stability, and set your business up for sustained success.
How to Calculate Total Debt: A Practical Example
Total debt represents the sum of all financial obligations a company owes, both short-term and long-term. To calculate total debt, you add together the company’s short-term debt (due within one year) and long-term debt (due in more than one year). This gives a clear picture of the company’s overall debt.
For instance, if a company has $50,000 in short-term debt and $150,000 in long-term debt, the total debt would be $200,000. This calculation helps assess the company’s financial health and its ability to meet financial obligations.
Example Balance Sheet
Let’s take an example of a company named ABC Corp. Here’s the balance sheet of the company:
|
ABC Corp Balance Sheet |
Amount ($) |
|---|---|
|
Assets |
|
|
Cash and Cash Equivalents |
50,000 |
|
Accounts Receivable |
30,000 |
|
Inventory |
20,000 |
|
Property, Plant, and Equipment |
200,000 |
|
Total Assets |
300,000 |
|
Liabilities and Equity |
Amount ($) |
|
Short-Term Liabilities |
|
|
Accounts Payable |
25,000 |
|
Short-Term Loans |
15,000 |
|
Current Portion of Long-Term Debt |
10,000 |
|
Total Short-Term Liabilities |
50,000 |
|
Long-Term Liabilities |
Amount ($) |
|
Long-Term Loans |
100,000 |
|
Bonds Payable |
50,000 |
|
Mortgages |
150,000 |
|
Total Long-Term Liabilities |
300,000 |
|
Total Liabilities |
350,000 |
|
Equity |
Amount ($) |
|
Owner’s Equity |
50,000 |
|
Retained Earnings |
100,000 |
|
Total Equity |
150,000 |
|
Total Liabilities and Equity |
500,000 |
Calculation of Total Debt
To calculate the total debt, we need to sum up the short-term liabilities and long-term liabilities.
- Short-Term Debt:
- Accounts Payable: $25,000
- Short-Term Loans: $15,000
- Current Portion of Long-Term Debt: $10,000
- Long-Term Debt:
- Long-Term Loans: $100,000
- Bonds Payable: $50,000
- Mortgages: $150,000
- Total Debt:
- Total Short-Term Debt: $50,000
- Total Long-Term Debt: $300,000
Total Short-Term Debt=$25,000+$15,000+$10,000=$50,000
Total Long-Term Debt=$100,000+$50,000+$150,000=$300,000
Total Debt=$50,000+$300,000=$350,000
Summary Table
|
Debt Type |
Amount ($) |
|
Short-Term Debt |
50,000 |
|
Long-Term Debt |
300,000 |
|
Total Debt |
350,000 |
By adding together the short-term and long-term debts from the balance sheet, we find that ABC Corp has a total debt of $350,000. This straightforward calculation helps in understanding the business’s financial obligations, allowing for better financial planning and management.
How Streamlining Collections Can Help Reduce Total Debt?
Managing total debt is a crucial aspect of maintaining a healthy financial status for small to mid-sized businesses. One effective way to manage and potentially reduce total debt is by streamlining the collections process. Here’s how a more efficient collections system can make a significant impact on reducing total debt.
1. Improved Cash Flow
Problem: Late payments can strain your cash flow, making it harder to meet debt obligations and forcing you to rely on more borrowing.
Solution: Streamlining collections ensures that invoices are paid promptly, improving cash flow. This reduces the need for additional short-term loans to cover operational expenses.
Example: Automating invoice reminders and follow-ups ensures customers pay on time, reducing the instances where you need to take out short-term loans to cover gaps in cash flow.
2. Reduced Bad Debt
Problem: Uncollected invoices eventually turn into bad debt, which can inflate your total debt figures if you need to borrow to cover these losses.
Solution: Efficient collections processes, such as regular follow-ups and clear payment terms, reduce the risk of invoices becoming bad debt. This means fewer write-offs and less need to borrow to cover these losses.
Example: Implementing a robust credit control system that flags overdue accounts early allows you to take timely action, reducing the amount of debt that becomes uncollectible.
3. Lower Interest Costs
Problem: High levels of outstanding debt often result in higher interest expenses, increasing your total debt over time.
Solution: By improving collections, you can pay down existing debts faster, thereby reducing the amount of interest accrued over time.
Example: Faster collections mean you can pay off a $50,000 loan quicker, saving on interest payments and reducing the overall debt burden.
4. Stronger Supplier Relationships
Problem: Poor cash flow due to delayed collections can strain your ability to pay suppliers on time, potentially damaging relationships and leading to less favorable credit terms.
Solution: Consistent cash flow from streamlined collections allows you to pay suppliers promptly, maintaining strong relationships and potentially negotiating better credit terms, which can reduce your overall debt.
Example: Consistent payments to suppliers can lead to them offering early payment discounts or extended payment terms, reducing your short-term debt requirements.
5. Enhanced Creditworthiness
Problem: High outstanding debt can negatively impact your credit rating, making it more expensive or difficult to borrow when necessary.
Solution: Efficient collections improve your financial metrics, demonstrating strong cash flow management and reducing your overall debt load, thus enhancing your creditworthiness.
Example: A business with timely collections can show a lower debt-to-equity ratio on its financial statements, making it more attractive to lenders and investors, potentially securing better loan terms.
How Can HighRadius Help?
HighRadius collections automation software, a component of the order to cash software, is powered by AI and offers a variety of features designed by experts to optimize your collections processes. Our extensive features include AI Prioritized Worklists, In-App Dialers, Intelligent Email Inboxes, Advanced Dunning, Generative AI via FreedaGPT, AP Portal Automation, In-App Payments Acceptance, Dispute Management, Proof of Delivery Automation, ERP Connectivity, Collection Agency Cases Integration, Customer Master Hierarchy Extensibility, and Activity Logging and Tracking. These modules streamline collections workflows, automate communication with customers, facilitate dispute resolution, integrate with ERP systems, and provide insights through data analytics, ultimately enhancing efficiency and effectiveness in your collections management.
FAQs
1) What is the total debt formula?
Total debt is calculated using the formula:
Total Debt = Short-Term Debt + Long-Term Debt
Total debt is the financial obligations that your business owes to others. It is usually categorized into short-term debts and long-term debts. Here, short-term debt is the finances within one year whereas long-term debt includes the financial obligations that lasts for more than a year.
2) Is total debt the same as total liabilities?
No, total debt includes only short-term and long-term borrowings, while total liabilities encompass all financial obligations, including accounts payable and other non-debt liabilities.
3) How is the total debt ratio calculated?
The total debt ratio is calculated by dividing total debt by total assets:
Total Debt Ratio = Total Debt ÷ Total Assets
4) What is the total debt to total assets ratio?
The total debt to total assets ratio measures the proportion of a company’s assets financed by debt. It is calculated as:
Total Debt to Total Assets Ratio = Total Debt ÷ Total Assets
