What is Net Debt?
Net Debt is a liquidity measure that determines how much debt a company has on its balance sheet relative to its cash on hand.
Conceptually, net debt is the amount of debt remaining once a company hypothetically paid down as much debt as possible using its highly-liquid assets, namely cash.
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How to Calculate Net Debt (Step-by-Step)
The net debt of a company represents the remaining debt balance once the company’s cash is used to help pay down as much debt as possible.
Frequently used to determine the liquidity of a company, the metric shows the remaining debt balance if all of a company’s cash and cash equivalents were hypothetically used to pay down its outstanding debt obligations.
The underlying idea behind net debt is that the cash sitting on a company’s balance sheet could hypothetically be used to pay down outstanding debt if necessary.
Since the assumption is that cash helps offset the debt burden, the value of a company’s cash and cash equivalents are deducted from the gross debt.
Calculating a company’s net debt balance consists of two steps:
- Step 1: Calculate the Sum of All Debt and Interest-Bearing Obligations
- Step 2: Subtract Cash and Cash-Equivalents
Net Debt Formula
The formula for calculating net debt is as follows.
- Debt Component → Comprises all short-term and long-term debt obligations, such as short-term and long-term loans and bonds — as well as financial claims such as preferred stock and non-controlling interests.
- Cash Component → Contains all cash and highly liquid investments — which refer to short-term holdings such as marketable securities, money market funds, and commercial paper.
How to Interpret Net Debt (Positive vs. Negative Value)
If the net debt of a company is negative, this suggests the company has a significant amount of cash and cash equivalents on its balance sheet.
The negative balance could be an indication the company is not financed with an excessive amount of debt.
In contrast, it could also just mean the company is holding onto more cash in comparison to debt (e.g. Microsoft, Apple).
Given a negative net balance, the enterprise value of these companies will be lower than their equity value. Recall that the enterprise value represents the value of a company’s operations – which excludes any non-operating assets.
Therefore, companies that have accumulated large cash reserves will have a higher equity value than enterprise value.
Net Debt Calculator – Excel Model Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Step 1. Cash and Debt Equivalents Model Assumptions
Here, our hypothetical company has the following financials in Year 0:
- Short-Term Borrowings = $40m
- Long-Term Debt = $60m
- Cash & Cash Equivalents = $25m
- Marketable Securities = $15m
For each period in the forecast, all debt and debt-equivalents are assumed to remain constant. Cash and marketable securities, on the other hand, are going to grow by $5m per year.
- Step Function, Debt = Constant (“Straight-Line”)
- Step Function, Cash = +$5 per year
Given the growth in cash and cash equivalents, while the debt amount remains constant, it would be reasonable to expect the company’s net debt to decrease each year.
Step 2. Net Debt Calculation Analysis
For Year 1, the calculation steps are as follows:
- Total Debt = $40m Short-Term Borrowings + $60m Long-Term Debt = $100m
- Less: Cash & Cash Equivalents = $30m Cash + $20m Marketable Securities
- Net Debt = $100m in Total Debt – $50m Cash & Cash Equivalents = $50m
Step 3. Net Debt-to-EBITDA Ratio Calculation Example
For our EBITDA assumption, we’ll be using $30m for each period in the forecast.
Since cash can be used to pay down debt, many leverage ratios use net rather than gross debt, as one could argue that net (not gross) debt is a more accurate representation of the company’s actual leverage.
From the completed output below, we can see how the net debt-to-EBITDA ratio declines from 2.0x in Year 0 to 0.3x by the end of Year 5, which is driven by the accumulation of highly liquid, cash-like assets.
But in the same time span, our total debt / EBITDA ratio remains constant at 3.3x as it does not take into account the growth in cash & cash equivalents.