Accounting Examples of Short-Term Debt vs. Long-Term Debt

by W D Adkins
Matching cash at hand and liabilities is one of the biggest challenges in business.

Matching cash at hand and liabilities is one of the biggest challenges in business.

For investors to make an informed decision about putting their money into a business, it is not enough to know how much debt the business owes. The debt obligations of a firm can be either short-term or long-term. How much of each type of debt a firm owes has a major impact on the firm’s liquidity, which is the business’s ability to meet its debt obligations.

Description

Debts, or liabilities, are the claims creditors have against a firm’s assets. Assets consist of anything that the firm owns that is of monetary value, such as real estate, equipment, cash and inventory. You will find a business' debts listed on its balance sheet in the liabilities section immediately following the section listing the firm’s assets. Liabilities are always divided into short-term debt and long-term debt. Short-term debt is referred to as current liabilities and long-term debt as long-term liabilities.

Short-Term Debt

Current liabilities include any obligations that are due within one year. Categories of short-term debt include accounts payable, accrued payroll and accrued payroll taxes. Current liabilities also include any payments in the upcoming year required to service long-term debt. For example, payments on a mortgage due in the next 12 months are considered current liabilities.

Long-Term Debt

A long-term debt is any liability owed by a business that is not due for more than one year. The principal balance of a mortgage is one common type of long-term debt. Another is the principal balance, or face value, of bonds sold by the corporation that will not mature for more than one year. The unpaid balance of a long-term lease is also a long-term liability. In some cases, retirement benefits due to employees are considered long-term liabilities.

Liquidity

Savvy investors use several measures to examine a firm’s debt position. Debt-to-equity is a ratio that gives you a picture of a company’s long-term liquidity. The debt-to-equity ratio is calculated by dividing the owner’s equity (or shareholder’s equity) into total liabilities. The higher the ratio, the lees liquid the business is over the long-term. Of at least equal importance is short-term liquidity. A common measure of short-term liquidity is the quick ratio. To calculate a quick ratio, subtract a firm’s inventory from its current assets. Divide the remainder by the current liabilities. The resulting ratio tells you how much money the firm has available to pay short-term debt. For example, assume a firm has $100,000 in current assets after excluding inventory and has $80,000 in short-term debt. Dividing out, you get 1.25. This means the firm has $1.25 in cash or cash equivalents available for each dollar of short-term debt.

About the Author

Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.

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