How Gross Debt and Net Debt Affect Investors

Investors can monitor the financial health of a company by understanding its debt. Gross debt is the total of the book value of a company’s debt obligations. Net debt is the company’s gross debt minus any cash and cash-like assets on the balance sheet. Net debt tells investors how much remains on the balance sheet if the company pays all obligations with its existing cash balances.

Key Takeaways:

• Gross debt is the total book value of a company’s debt obligations.
• Net debt is the book value of a company’s gross debt minus any cash and cash-like assets on the balance sheet.
• Net debt is a liquidity metric used to determine how well a company can pay all its debts if they come due immediately.

What Is Gross Debt?

A debt is money borrowed from another entity. Debts typically involve paying interest to the lender and may include bank loans, mortgages, and bonds. Gross debt is the total debt a company has at a specific time. For example, if a small business borrows $40,000 from a bank and $10,000 from a family member and has no other debts, the gross debt is $50,000.

Burdensome debt loads can be problematic for company stakeholders. Just because a company has more debt does not necessarily mean it is financially worse off than a company with less debt. For example, what may appear to be a large debt load on a company’s balance sheet may be smaller than an industry competitor’s debt on a net basis. Investors can look to net debt to further evaluate the company’s books.

Note

Net Debt = Short Term Debt + Long Term Debt – Cash or Cash Equivalents

Evaluating Net Debt

Net debt reveals additional details of a company’s financial health beyond gross debt. Net debt compares metrics between industry peers. A company’s balance sheet is used to calculate net debt. Net debt also provides insights into a company’s operational strategy.

If the difference between net and gross debt is substantial, the company has a large cash balance along with significant debt. This may occur due to liquidity concerns, capital investment opportunities, and planned acquisitions. Therefore, net debt should be examined using an industry benchmark and company strategy.

Why Is Net Debt Important During an Acquisition?

Net debt is a key factor during a buyout. When a buyer is looking to acquire a company, net debt is more relevant than gross debt from a valuation standpoint. A buyer is not interested in spending cash to acquire cash. It is more meaningful for the buyer to use the target company’s debt net of its cash balances to accurately assess the acquisition.

What Is the Difference Between Short-Term and Long-Term Debt?

Short-term debt is due in one year or less and can include short-term bank loans, accounts payable, and lease payments. Long-term debt has a maturity date over one year and includes bonds, lease payments, and term loans.

What Is Enterprise Value?

Enterprise value (EV) measures a company’s total value. It measures the market capitalization of a company, its short-term and long-term debt, and any cash or cash equivalents on the company’s balance sheet. Enterprise value is often used as a more comprehensive alternative to market capitalization when valuing a company.

The Bottom Line

Gross debt is the total book value of a company’s debt obligations that includes short term and long term debt. Net debt is gross debt minus any cash and cash-like assets on the balance sheet. Net debt tells investors how liquid a company is and how well the business can pay its debts if they come due immediately.