When investing in stocks, real estate, or other assets, it's important to understand the financial health of the company or asset. Among these, 'debt' is one of the essential items to check. So today, we will learn what debt is and why it's important.

Financial Statements - Debt

Basic Concept

In financial statements, the term 'debt' refers to the obligations that a company needs to repay. This includes money borrowed from external organizations or individuals, unpaid bills, and advance payments. Investors should pay close attention to debt because it impacts a company's financial status and future cash flow.

Debt typically has a set maturity date and interest rate. The maturity date indicates when the company must repay the debt, while the interest rate determines the amount of interest the company must pay on the debt. High interest rates or short maturities can increase a company's financial costs and create financial pressure. Investors should consider these factors.

There are various types of debt, and understanding each type's characteristics is crucial. For example, short-term debt needs to be repaid within a year, while long-term debt can be repaid over a longer period. Current liabilities are debts that the company must repay immediately, while non-current liabilities are debts that can be deferred for a period. By understanding the nature and conditions of each debt, you can more accurately assess the company's financial situation.

Debt Classification and Types in Financial Statements

Debt is broadly classified into current liabilities and non-current liabilities.

• Current liabilities are debts that must be repaid within a year, including accounts payable, short-term borrowings, accrued expenses, and advance payments. These debts are critical indicators for evaluating a company's short-term financing and repayment capacity.
• Non-current liabilities are debts that must be repaid after a year, including bonds, long-term borrowings, and retirement benefit obligations. These debts are related to a company's long-term financing and repayment plan and play a critical role in determining its stability and growth potential.

Debt Types include borrowings, bonds, accrued expenses, and advance payments.

Borrowings are loans obtained from financial institutions such as banks, divided into short-term borrowings and long-term borrowings. Bonds are securities issued by a company, a major direct financing tool along with stocks. Accrued expenses are amounts owed by a company for goods or services received but not yet paid, while advance payments are funds received from customers before providing goods or services.

All this debt information is recorded in financial statements. Investors must carefully review this information to assess a company's financial status and repayment ability.

Debt Ratio and Its Importance

The debt ratio is a key indicator for evaluating a company's financial stability, calculated by dividing total debt by equity. A higher ratio indicates a higher reliance on debt for the company, signifying increased financial risk.

Generally, a debt ratio of 100% or less is considered appropriate. However, there may be variations depending on the industry or company's characteristics. For example, manufacturing companies may have a higher debt ratio due to large investments in equipment, while financial companies may have a relatively lower debt ratio due to their high reliance on debt for operations.

Companies with high debt ratios may experience decreased profitability due to increased financial expenses like interest payments. Higher repayment pressure can also increase the risk of default. On the other hand, companies with low debt ratios have a stable financial structure, are more responsive to economic fluctuations, have higher creditworthiness, and enjoy easier access to financing.

Therefore, investors must check a company's debt ratio. This information helps evaluate the company's financial status and repayment capacity and aids in making investment decisions. Furthermore, tracking debt ratio changes over time is crucial to understand if a company's financial health is improving or deteriorating.

Difference Between Long-Term Debt and Short-Term Debt

Debt is categorized into long-term debt and short-term debt based on the repayment period.

• Long-term debt refers to debt with a repayment period of one year or more. Typically, this includes bonds or loans issued by companies for long-term financing needs. Long-term debt allows companies to use funds stably for longer periods but can impact profitability due to higher interest costs.
• Short-term debt refers to debt with a repayment period of less than a year. This primarily involves loans obtained from banks or funds raised by issuing commercial paper (CP) to meet short-term financing needs. Due to its shorter maturity, repayment pressure is higher, and short-term debt is sensitive to interest rate fluctuations, significantly impacting a company's financial stability.

Therefore, investors should understand the size and composition of long-term and short-term debt in a company's financial statements. This helps understand a company's financing and utilization patterns and evaluate its financial stability.

Impact of Debt Management on Companies

Debt management significantly impacts a company's financial status and business performance. Poor management can lead to decreased creditworthiness, difficulty in securing financing, and increased risk of bankruptcy. However, proactive management can improve financial stability, reduce financing costs, and enhance profitability.

First, the debt ratio is a primary indicator of a company's financial safety. A higher ratio implies weaker debt repayment capacity, potentially leading to negative assessments in the capital market. This can result in higher financing costs or even difficulty in securing financing.

The interest coverage ratio, which measures a company's ability to cover interest expenses with operating income, is also crucial in debt management. A ratio below 1 indicates that the company cannot cover interest expenses with operating income, raising concerns about the company's survival.

Lastly, the debt repayment schedule is important. Concentration of payments at a specific time can lead to liquidity crises, so it is best to distribute them.

Debt-Related Indicators Investors Should Know

Investors must review several indicators to understand a company's debt situation.

• Firstly, it's the debt ratio. This is calculated by dividing a company's total debt by equity, a key indicator for assessing financial health. While a ratio below 100% is generally considered appropriate, industry variations exist.
• Secondly, it's the interest coverage ratio. This is calculated by dividing operating income by interest expenses, indicating whether a company can adequately cover interest costs. A ratio below 1 means the company cannot cover interest expenses with operating income. If the ratio stays below 1 for three consecutive years, the company is considered borderline.
• Finally, it's the debt dependence ratio (debt/total assets). A ratio of 30% or higher is considered excessive, indicating vulnerability during economic downturns.

By analyzing these debt-related indicators, investors can gain a more accurate understanding of a company's financial status.