Book Value of DebtDefined along with formula and more

Businesses will sometimes avail of debt to finance their operations.

A common example of this is when a business takes out a loan from a bank to purchase high value assets such as cars, buildings, machinery, equipment, etc.

Typically, bank loans come with interest which means that on top of repaying the loan amount, the borrower has to pay additional interest too.

It’s the price to pay in exchange for a quick injection of cash.

A business needs to properly account for all of its debts.

This ensures that it will pay all of its liabilities, and more importantly, that it does not overpay.

Properly accounting for debts also helps in determining the value of the business.

It helps in gauging how much of the business is financed by debt (as well as equity).

In this article, we will be learning about the book value of debt.

What is it?

How does one compute for it?

Is it significant for a business?

We will be answering these questions as we proceed along with the article.

What is the Book Value of Debt?

The book value of debt refers to the amount of debt that appears on a business’s books and balance sheet.

It is a historical recording of the debts that the business has accumulated over its years of operation.

It includes the following:

• Long-term debt
• Current portion of long-term debt
• Notes Payable
• Other interest-bearing debts

As you can see from the above list, only interest-bearing debts are included.

Other liabilities such as accounts payable or accrued liabilities are missing from the list.

This is because these short-term debts are expected to be settled within the current period.

Also, they are non-interesting bearing liabilities.

The book value of debt is one of the metrics that analysts and investors use to gauge a business’s worth and future viability.

It is often used in the calculation of the business’s liquidity (where it is compared to the business’s total assets).

It helps in determining whether the business has enough resources to shoulder all of its debts.

Do note that the book value of debt does not account for the amount of interest that the debts carry.

It only accounts for the principal amount that the business still owes.

The Components of the Book Value of Debt

Let’s talk about the components of the book value of debt:

Long-term debt

These refer to liabilities that only become payable after a year or so.

Bank loans and other long-term debt instruments fall under this category.

Due to their long-term repayment, these liabilities often carry an interest component to them.

This means that on top of repaying the principal amount, the business will also have to make interest payments.

Current portion of long-term debt

Eventually, a business will have to repay its long-term debts.

The current portion of long-term debt refers to the amount that the business has to pay within the current period.

For example, a business was extended a 5-year loan.

Annual payments start in February 2022 until the end of the loan.

For the financial year 2022, the portion of the loan that the business has to pay in the year 2022 is its current portion.

It’s important to always stay on top of the current portion of your long-term debts.

Not paying them on time often comes with hefty penalties such as late fees or additional interest.

Notes Payable

Notes payable refer to long-term liabilities that are represented by a note (often a promissory note).

They indicate how much money the business owes to the holder of the note.

In exchange for receiving a certain amount of money from the lender, the business promises to pay it back with interest over a set amount of time, usually spanning more than a year.

Some notes payable come with collateral.

This is to secure payment of the debt on the part of the lender.

If the business is unable to pay its debt, the lender can claim the collateral to pay for the debt instead. Notes payable with collateral often have longer terms.

Other Interest-Bearing Debts

Debts that don’t fall under the previous three categories belong to other interest-bearing debts.

As long as the debt carries with it an interest component, it should be included in the computation of the book value of debt.

Book Value of Debt Formula

Calculating the book value of debt is quite simple.

You only need to add up all of its components.

That means getting the sum of all interest-bearing liabilities.

Put into formula form, it should look like this:

Book Value of Debt = Long-term Liabilities (Current and Non-current Portion) + Notes Payable + Other Interest-Bearing Liabilities

To further understand the formula, let’s have an example.

Let’s say that GJ company has the following interest-bearing debts:

• Bank Loans (Current Portion) – $120,000
• Bank Loans (Non-Current Portion) – $720,000
• Notes Payable – $380,000
• Finance Lease (Current Portion)- $70,000
• Finance Lease (Non-Current Portion) – $560,000

Before we proceed, let’s determine first which category each debt belongs to.

First, let’s determine the current portion of long-term debts.

From the information above, we gather the following:

• Bank Loans (Current Portion) – $120,000
• Finance Lease (Current Portion)- $70,000

Adding these all up, we arrive at a total of $190,000 ($120,000 + $70,000) current portion of long-term debts.

Next, let’s determine the non-current portion of long-term debts.

As per the information above, we gather the following:

• Bank Loans (Non-Current Portion) – $720,000
• Finance Lease (Non-Current Portion) – $560,000

As a result, the total for the non-current portion of long-term debts amounts to $1,280,000 ($720,00 + $560,000).

Next, let’s determine the total notes payable.

As per the information above, we gather the following:

• Notes Payable – $380,000

Lastly, let’s determine if there are other interest-bearing debts.

Looking once again at the information above, the GJ company does not have other interest-bearing debts.

Now that we all have the components, we can proceed with the computation of the book value of debt:

Book Value of Debt = Long-term Liabilities (Current and Non-current Portion) + Notes Payable + Other Interest-Bearing Liabilities

= ($190,00 + $1,280,000) + $380,000 + $0

= $1,850,000

Book Value vs Market Value of Debt

The book value of debt provides us with a simple calculation of the total debt that a business is carrying.

With it, we can already compute the cost of carrying such debts.

Also, while it’s simple, it can still help us in gauging the liquidity and solvency of a business.

It’s enough to provide us with the principal amount of debt that the business still owes.

However, when it comes to the valuation of the business as a whole, the book value of debt might not be the most reliable or relevant piece of information.

Instead, we look at the market value of debt for that.

The market value of debt refers to the price that investors or buyers are willing to pay for the business’s debts.

In short, it is how the market values the business’s debts, which isn’t always equal to its book value.

This only becomes relevant when the business is intending to sell itself or enter into a merger.

Otherwise, the book value of debt should suffice to gauge whether a business has the capacity to pay for its liabilities.

The calculation of the market value of debt is more complicated than that of its book value.

You need to consider the current market conditions, as well as follow a fairly complicated formula.

In contrast, all you need to compute the book value of debt is to identify its components and then add it all up.

So for internal uses, the book value of debt should suffice.

It already tells us the relevant information that the business has to know regarding its debts.

The principal amount of debt usually only changes when the business pays for it, or when it accumulates additional debt after all.

The market conditions rarely affect it.