Book Value Of Debt Definition Formula Calcuation With Examples

Book Value of Debt Definition

The book value of debt is the total amount the company owes, which is recorded in the company’s books. It is used in Liquidity ratios, where it will be compared to the total assetsTotal AssetsTotal Assets is the sum of a company’s current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equityread more to check if the organization has enough support to overcome its debt. This Book value can be found in the Balance SheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more under Long Term Liability and Current liability head.Current Liability Head.Current Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more

Book Value of Debt – Components

It consists of the following components in the balance sheet,

Long term DebtLong Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company’s balance sheet as the non-current liability.read more, will be found in the long-term liability head in the balance sheet.Current portion of Long-term DebtCurrent Portion Of Long-term DebtCurrent Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets.read more, will be part of the Current liability head in the balance sheet.Promissory NotesPromissory NotesA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date.read more (Note PayableNote PayableNotes Payable is a promissory note that records the borrower’s written promise to the lender for paying up a certain amount, with interest, by a specified date. read more), it would be found in the current liability head in the balance sheet.

Book Value of Debt Formula

Below is the formula to calculate the Book Value of the Debt

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How to Calculate Book Value of Debt?

It is calculated to make a sum of money borrowed and is due to be paid on the Balance sheet. All we need to do is add all the long-term Liabilities and some of the components in the Current LiabilitiesComponents In The Current LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more.

Long-term Liabilities include Long term loans from Banks or other financial institutions and DebenturesDebenturesDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer.read more. From the balance sheet, one can easily calculate this Book value.

Example

let’s take one example.

Below is the balance sheet of M/s XYZ Corporation as of March 31st, 2019. We will look at the liabilities side to find out the total debt in the company.

We can see in the above balance sheet of M/s XYZ Corporation that the Total long-term Debt is $200,000, and Notes Payables are $10,000.

The next step is to calculate the book value of debt by employing the above formula,

Book Value of Debt = Long Term Debt + Notes Payable + Current Portion of Long-Term Debt=USD $ 200,000 + USD $ 0 + USD $ 10,000= USD $ 210,000

So, we can see that the Debt for XYZ Corporation is $210,000, which would be different from the market value of debt.

Advantage

It has many advantages as compared to the market value of Debt. Below are the main advantages one can see with it,

Easy to Calculate: It is easy to calculate; as per the above formula, we can calculate it by looking at the company’s balance sheet. We have to add all long-term and current liabilities, which will give the Book value of the Debt.It gives us the actual value of debt that a company owes to its lenders or other stakeholders, which is recorded in the books. This Book value changes only when the company updates its financial statements quarterly or annually, and it does not change as per the market situations.

Disadvantages

As we have seen some of the advantages, this has some disadvantages as well; some of them are as follows:

The book value of Debt is not so accurate when compared with the Market value of Debt. It is derived directly from the financial statements, so it is not affected by current market situations or interest rates.It changes over periodical intervals, i.e., monthly, quarterly, or annually. If someone wants to know the current book value of Debt, he has to wait for updated financial statements.Book value of debt is the accounting value of the debt, which was recorded as per the historical data or amortization schedule of the debt, which will have less relevance at the time when the company is looking for a merger or acquisition or looking for any other external investors for the company.

Limitations

There are some limitations of the Book Value of Debt when compared to the Market value of Debt; some of the major limitations are as follows,

One of the major issues with the Book value of Debt is that all financial statements are updated quarterly or annually. If one wants to see the exact amount of debt from the financial statement, one has to wait for the company’s quarterly or annual financial statements from the companyAnnual Financial Statements From The CompanyAnnual Financial Statements refers to the annual presentation of the entity’s financial performance comprising a Balance Sheet, statement of profit and loss, statement of changes in equity, cash flow statement, and notes to the financial statements. It provides information to the stakeholders for making financial decisions about the business.read more.It would be adjusted per the accounting standards and subject to adjustment, which is difficult to understand and track.It does not give the exact position of the net debt that the company would have actually. To get the exact position of the net debt, we have to consider the market value of Debt.It could be used for empirical finance only as it does not consider the current market situations and interest rates for calculating a net debt for the company.It does not help stakeholders and investors calculate the company’s total Enterprise ValueTotal Enterprise ValueEnterprise value (EV) is the corporate valuation of a company, determined by using market capitalization and total debt.read more.The book value of debt is accounted for in the financial statements based on the amortization schedule of the debt or historical costHistorical CostThe historical cost of an asset refers to the price at which it was first purchased or acquired.read more.

Effect of Changes in Book Value of Debt

It is the sum of the total debt recorded in its balance sheet and is useful in calculating the firm’s liquidity ratios. So changes in the book value of Debt will affect in the following manner,

Changes in this Book value will affect its liquidity ratios. Liquidity ratios are useful in knowing the firm’s capability to support its total debt.Suppose the Book value of debt has increased over time. In that case, the company’s capability has decreased to support its total debt, which means that compared to its total assets, the company has more debt on its balance sheet. It would be difficult for the company to pay off its debt in the future.The company has to put its assets as collateral with the banks or other financial institutes, so changes in this book value will also affect the value of the collateral securities with the banks or other financial institutes.

Conclusion

So, from the above discussion, we can conclude this in following heads,

It is the total money that the company owes and recorded in its books of the company.It is one of the things to look at when we are investing or loaning the money in any company. Yet, it is not an accurate way to calculate the total net debt of the companyNet Debt Of The CompanyDebt minus cash and cash equivalents equals net debt, which is the amount of debt a company has in comparison to its liquid assets. It is a metric that is used to evaluate a firm’s financial liquidity and aids in determining if the company can meet its obligations by comparing liquid assets to total debt.read more. We have to consider the market value of debt for a proper understanding of the company.It is the sum of Long-term debt, the Current portion of long-term debt, and notes payable on the balance sheet.It is useful to calculate the company’s liquidity ratios to see if the organization can support its debt load.One of the main limitations of the book value of Debt is that it is updated quarterly or annually with the company’s financial statement, so only after a quarter or annual financial statement reporting would the investor be aware of how the company’s book value has changed over the time.It may be different than the market value of the firm.