Net Debt

Table of Contents

What is Net Debt?

Net debt is the debt owed by a company, net of any cash balances or cash equivalents. It is calculated as the sum of all interest-bearing liabilities less any highly liquid financial assets, mostly cash and cash equivalents. Net debt is a useful liquidity metric for understanding the level of indebtedness of a company. It is used widely in equity valuation and credit analysis and is summarized as:

Net Debt Formula

Net debt = Total interest-bearing liabilities – Highly liquid financial assets

Items Included in Net Debt

There are several items that may be included in the net debt calculation. Below we outline the most common items used. All the items can be found in a company’s balance sheet.

Liquid Financial Assets

Cash and cash equivalents include all cash and highly liquid assets with a short term to maturity (generally 90 days or 3 months). It is always reported under the current assets section of the balance sheet. Companies will usually provide additional information on their cash equivalents in the footnotes section of their financial reports.

Here are some examples of common items included in cash and cash equivalents:

All of these items are highly liquid meaning they can be quickly converted to cash with no loss of value.

Debt

Debt refers to an amount of money borrowed from one party by another on the condition that it is repaid at a later date. There is usually a requirement to pay interest on top of the repayment of the borrowed amount. The loan represents an obligation where the issuer is required to deliver either cash or another financial asset in repayment of the borrowed amount. It is always reported as a liability in a company’s balance sheet.

Operating liabilities such as accounts payable, deferred revenues, and accrued liabilities are all excluded from the net debt calculation. These do not bear any interest, so they are not considered to be financing in nature.

Examples of Debts:

Calculating Net Debt

Use the information below to calculate net debt for both years:

First, you must identify and sum all the debt items. The cash and cash equivalents are then subtracted from the total debt.

Net debt is initially high. The company has more debt than cash. Year two has been a good year for the company. It has paid down a lot of debt and amassed a lot of cash. It now has negative net debt. It has more cash than debt.

Take a look at the net debt example download if you’d like to practice calculating net debt.

Applications of Net Debt

There are two main uses of net debt.

Enterprise and Equity Valuation

Net debt is used in the Equity and EV value bridge. Enterprise value is the value of the operational business, independent of capital structure. Equity value (or market capitalization) is the value attributable to the owners or shareholders (frequently expressed on a per share basis for public companies). The enterprise value equals net debt plus equity value, enterprise value can be derived from equity value and vice versa. If cash were needed to support trade, such as restricted cash, this wouldn’t be available to set against debt and should be excluded. However, for valuation purposes it is generally assumed that cash is excess cash and part of the capital structure.

Credit Analysis

Net debt is used in many frequently used leverage ratios, including net debt/equity and net debt/total capital and also within the net debt/EBITDA ratio to measure a company’s ability to service its debt using recurring operating earnings. Using net debt rather than total debt with regard to credit analysis assumes the company could use its cash reserves to pay back debt if the company were to experience financial distress.