What is Net Debt?

It helps us understand how a company is doing debt-wise. It helps the investors have a closer look at where a company stands in terms of liabilities. The liabilities of a company shouldn’t exceed the company’s cash inflows. Otherwise, it would be impossible for a company to pay off its dues when the time is due.

Net Debt Formula

Here’s the formula –

Net Debt = (Short Term Debt + Long Term Debt) – Cash & cash Equivalents

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In the net debt formula above, we have three components.

  • The first component is the short-term debt. Short-term debts are called current debts. They can be due in less than a year. Current debts may include a short-term loan, a short-term payment of a long-term loan, etc.The second component of the formula is long-term debt. The long-term debt is due in the long run. But the companies need to make sure that the long-term debt is paid off when it is due (that may mean making periodic payments or paying at the end of the tenure).The third and the last components are cash & cash equivalents. Cash & cash equivalents include cash on hand, a liquid investment with a maturity of three months or less, checking accounts, treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more, etc.

The idea is to see how much debt would still be left by removing the cash & cash equivalents from the picture (as it is already in ownership of the company). It means that if all the cash & cash equivalents are used to pay off a portion of the company’s total debt, how much debt would still be left for the company to pay off.

Examples

  • Short term debt of the company – $56,000Long term debt of the company $644,000Cash & Cash Equivalents – $200,000

Find out the debt position on behalf of Ramen.

Using the formula of net debt = (Short Term Debt + Long Term Debt) – Cash & Cash Equivalents

  • = ($56,000 + $644,000) – $200,000 = $500,000.

To know whether it is lower or higher, we need to look at other companies in the same industry.

Colgate Example

Below is the balance sheet of Colgate of 2016 and 2017.

source: Colgate 10K Filings

Net Debt Formula = Short Term Debt + Long Term Debt – Cash and Cash Equivalents.

Colgate’s Debt (2017)

  • Short-Term Debt of Colgate = 0Long-Term Debt of Colgate = $6,566 millionCash and Cash Equivalent = $1,535 millionNet debt (2017) = 0 + $6,566 – $1,535 = $5,031 million

Colgate’s Debt (2016)

  • Short-Term Debt of Colgate = 0Long-Term Debt of Colgate = $6,520 millionCash and Cash Equivalent = $1,315 millionNet debt (2017) = 0 + $6,520 – $1,315 = $5,205 million

Uses

For every investor, it is important to know whether a company is doing well financially or not. Thus, to check whether a company is in financial distressFinancial DistressFinancial Distress is a situation in which an organization or any individual is not capable enough to honor its financial obligations as a result of insufficient revenue. It is usually the result of high fixed costs, obsolete technology, high debt, improper planning and budgeting, and poor management, and it can eventually lead to insolvency or bankruptcy.read more, they use the net debt formula. This formula helps them understand the true financial stance of a company.

  • A larger debt and a larger cash & cash equivalents will lower net value. A lower value is an indication that the company is doing quite well. It means the company is in great shape financially to pay off its debt.On the other hand, the higher net value is an indication that the company has not been doing pretty well financially.

Knowing this will help the investors decide whether they should invest in the company’s stock or not.

Net Debt  Calculator

You can use the following Net Debt Calculator.

Net Debt Formula in Excel (with excel template)

Let us now do the same example above in Excel.

This is very simple. You need to provide the three inputs of Short Term Debt, Long Term Debt, and Cash & Cash Equivalents.

You can easily calculate debt in the template provided.

Video on Net Debt Formula

This has been a guide to Net Debt and its definition. Here we discuss the formula to calculate net debt, practical examples, uses, and interpretation. We also provide you with a Net Debt Calculator with a downloadable excel template.

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