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 = Total interest-bearing liabilities – Highly liquid financial assets

Items Included in Net Debt

There are several items which 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:

Cash and cash equivalents
Commercial paper
Short term deposits
Marketable securities
Money market instruments
Foreign government treasury bills

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 debt:

Short-term debt (Due within 1 year)
Overdraft
Notes payable
Short term debt
Commercial paper
Revolving credit facility
Current portion of long-term debt
Long-term debt (Due beyond 1 year)
Bonds
Bank loans
Loan notes
Debentures
Long term debt
Convertible debt (bond proportion only)
Capital/finance leases
Preference shares (if treated as debt)

Calculating Net Debt

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

Year 1 Year 2
Short term borrowings 2,708.0 1,592.0
Long term debt due within one year 2,745.0 4,791.0
Capital lease due within one year 551.0 297.0
Long term debt 38,214.0 40,889.0
Long term capital lease 5,816.0 2,606.0
Cash and cash equivalents 8,705.0 9,125.0

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

Year 1 Year 2
Total debt 50,034.0 50,175.0
Cash and cash equivalents (8,705.0) (9,125.0)
Net debt 41,329.0 41,050.0

The net debt is lower than the total debt. This provides a more accurate representation of the company’s liquidity position and true level of indebtedness.

Applications of Net Debt

There are two main uses of net debt.

Enterprise and Equity Valuation

Net debt is used in the Equity to EV 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).

Valuing a business on the basis of enterprise value allows for better comparison across companies of differing capital structure.

Enterprise value is calculated as net debt plus equity value. For valuation purposes, the net debt should be included at market value instead of book value or balance sheet amounts. This approach assumes that cash is excess cash.

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 regards to credit analysis assumes the company could use its cash reserves to pay back debt if the company were to experience financial distress.