When you are investing in a company, there are several components that must be considered. One of the most important ones is the net debt of the company. To effectively analyze a company’s debt, an investor must consider the following questions:
- How much debt is there?
- What is the debt for?
- What kind of debt is it?
- What is the debt level of comparable companies?
An easy way to consider the level of net debt that a company has is to determine if a company would be able to pay its debt if they were all due immediately. This evaluation helps analysts determine if a company can afford its debt – or if it is overextended and carrying an excessive amount of debt.
Calculating net debt is done by adding the short and long term debt amounts, and then subtracting the amount of cash on hand. The resulting figure indicates the net debt that the company has.
That calculation can be important to an investor who wants to invest in a company that will be able to survive market fluctuations and recessions. Companies who have large amounts of cash on hand, but are carrying larger amounts of debt will be in a better position than the company who may not have as large debts but has smaller amounts of cash.
Understanding the impact of debt on a company’s ability to weather economic turbulence can determine the viability of the investment. A company may have a large amount of debt due to a recent expansion or the purchase of a new warehouse, indicating that the debt is new and has the potential for growth. A company with large amounts of old debt may indicate that the company is having trouble paying its bills and may not be a wise investment.
As with all financial reports, taking only one piece of a company’s financials does not give a clear indication of the overall health of the company. Using professional financial advisors can ensure that the reports are accurate and give verifiable information, and should be taken into consideration only with the complete picture of the company.