Net Debt

What is Net Debt?

Net debt is a financial liquidity metric that measures a company’s current interest-bearing debt and nets the debt against cash and cash-like items. In other words, net debt compares a company’s total debt with its liquid assets. Net debt is the amount of debt that would remain after a company had paid off as much debt as possible with its liquid assets. It is commonly used in valuation, as well as to determine if a company can repay its obligations if they were all due immediately and whether the company is able to take on more debt.

Formula for Net Debt

Net Debt = Short-Term Debt + Long-Term Debt – Cash and Equivalents

Where:

• Short-term debts are financial obligations that are due within 12 months. Common examples of short-term debt include short-term bank loans and commercial paper.
• Long-term debts are financial obligations that are due beyond a 12-month period. Common examples of long-term debt include bonds, lease obligations, contingent obligations, notes payable, and convertible bonds.
• Cash and cash equivalents are the most liquid assets of a company. Common examples of cash and cash equivalents include marketable securities, treasury bills, and cash in bank accounts.

Example Calculation of Net Debt

Company A reported a drawn line of credit of $10,000 and a current portion of long-term debt of $30,000. Long-term liabilities of Company A consist of a $50,000 long-term bank loan and $50,000 in bonds. Current assets of Company A include $15,000 in cash, $10,000 in Treasury bills, and $15,000 in marketable securities.

The net debt of Company A would be calculated as follows:

• Short-term debt: $10,000 + $30,000 = $40,000
• Long-term debt: $50,000 + $50,000 = $100,000
• Cash and cash equivalents: $15,000 + $10,000 + $15,000 = $40,000

($30,000 + $10,000) + ($50,000 + $50,000) – ($15,000 + $10,000 + $15,000) = $100,000

Below is a screenshot of the above calculation for Company A, along with two other companies. Company B has a net cash position, and Company C has a zero balance.

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Interpretation of Net Debt

Net debt is simply the total debts of a company subtracted from a company’s most liquid assets. Essentially, it gives analysts and investors insight into whether a company is under- or overleveraged. A negative net debt implies that the company possesses more cash and cash equivalents than its financial obligations, and hence is more financially stable.

However, the net debt metric should not be used alone to determine a company’s financial health. It should be used in conjunction with other liquidity and leverage ratios such as the current ratio, quick ratio, debt ratio, debt-equity ratio, etc.

Negative Net Debt (Net Cash)

Companies that have little to no debt will often have a negative net debt (or positive net cash) position. A negative amount indicates that a company possesses enough cash and cash equivalents to pay off its short and long-term debts and still has excess cash remaining.

The Importance of Net Debt

This metric is used to measure a company’s financial stability and gives analysts and investors an indication of how leveraged a company is. Companies with a negative net debt are generally in a better position to withstand adverse economic changes, volatile interest rates, and recessions.

As it can be a helpful indicator of financial health, investors use it when determining whether to buy or sell shares of a company. Nonetheless, it should be used in conjunction with other financial ratios to provide an accurate representation of a company’s financial health.

Use in Enterprise Value

The Enterprise Value of a business is equal to its equity value plus its net debt. The reason that cash is deducted from debt is that it can be used to net out any amounts that are owed to creditors. For business valuation purposes, enterprise value is used in many valuations. Learn more about enterprise value vs equity value.

Related Readings

Thank you for reading CFI’s guide to Net Debt. To continue learning and advancing your career, these additional CFI resources and guides will be helpful:

• Debt to Equity Ratio
• Capital Structure
• Debt Capacity
• Senior and Subordinated Debt
• See all valuation resources
• See all commercial lending resources