Short-term debt is defined as debt obligations that are due to be paid either within the next 12-month period or the current fiscal year of a business. Short-term debts are also referred to as current liabilities. They can be seen in the liabilities portion of a company’s balance sheet.
Short-term debt is contrasted with long-term debt, which refers to debt obligations that are due more than 12 months in the future.
Short-term debt is most commonly discussed in reference to business debt obligations but can also be applied in the context of personal financial obligations.
Short-term debt is defined as the portion of a company’s total debts that are due to be paid within either the next 12 months or within the company’s current fiscal year.
Short-term debt is separated from long-term debt, which consists of debt obligations a company has whose repayment period extends more than 12 months into the future.
Common examples of short-term debt include accounts payable, current taxes due for payment, short-term loans, salaries, and wages due to employees, and lease payments.
Types of Debt
The debt obligations of a company are commonly divided into two categories – financing debt and operating debt.
Financing debt refers to debt obligations that arise from a company borrowing money to fund the expansion of its business. An example of financing debt may be taking out a large bank loan or issuing bonds to fund a major capital expenditure, such as the construction of a new plant.
Financing debt is typically long-term debt since the amount of debt incurred is usually too large for a company to be able to reasonably repay in full within one year.
Short-term debt more commonly consists of operating debt, incurred during a company’s ordinary business operations.
The most common example of short-term debt is a company’s accounts payable, which is the money it owes to suppliers or providers of services the company uses, and that is usually expected to be paid off within the very near term.
Examples of Short-Term Debt
Short-term debt may exist in several different forms. Some of the most common examples of short-term debt include:
Accounts Payable – Accounts payable includes all the money a company owes through ordinary credit purchases from suppliers, such as purchases from wholesalers to stock its products. It also includes monthly bills, such as utility bills and office rent.
Short-Term Loans – A company often needs to take out a short-term loan from a bank or other lending institution to help it bridge a cash flow problem. If a company is having trouble collecting its accounts receivable, that can make it difficult to cover its accounts payable. The company may take out a short-term loan, such as a 90-day note, which is due to be repaid within three months.
Commercial Paper – Instead of taking out a bank loan, some companies choose to issue commercial paper – unsecured promissory notes that typically come due in nine months or less.
Lease Payments – It’s common for many companies to lease, rather than purchase, The payments on such leases that are due within the next 12 months are a component of the company’s short-term debt.
Taxes Due – The tax component of short-term debt includes any local, state, federal, or other types of taxes that a company may owe that are due to be paid within the current year.
Salaries and Wages – All salaries due to be paid to employees within the current year are also considered part of short-term debt.
Stock Dividends – If a company has declared, but not yet paid, stock dividends to its shareholders, the dividends are part of the company’s short-term debt.
Assessing a Company’s Debt
Financial analysts typically use several financial metrics to examine a company’s debt liability to determine how financially sound the company is. Two commonly used ratios that focus on a company’s short-term debt obligations are the current ratio and the working capital ratio.
Current ratio is calculated as the company’s current assets divided by its current liabilities. It indicates the company’s ability to meet its short-term debt obligations with relatively liquid assets.
A current ratio of 1.0 indicates that the company’s liquid assets roughly match its current liabilities. A ratio higher than 1.0 indicates that its current assets are more than sufficient to meet its current debt obligations.
Working capital ratio is the sum of current assets minus current liabilities. Any positive number indicates that a company holds excess capital beyond that which is required to pay off its short-term debt.
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