Accounting: Short-Term vs. Long-Term Debt
Short-term Debt is a Current Liability on the Balance Sheet. It is an obligation that will be repaid within one year. Short-term Debt includes such liabilities as payroll taxes, deferred revenue and a revolving Line of Credit.
Long-term Debt appears in the Non-Current Liability section of the Balance Sheet since they will be retired beyond the current year. Long-term Debts include mortgages, promissory notes, and lease obligations.
Some portion of all long-term liabilities converts to short-term on a rolling monthly basis. If a company has a loan payable that will be repaid over several years, only the principal due in the next twelve months is reported as short-term debt. The remaining principal is reported as long-term debt. Each month as you pay the short-term principal, one month from the long-term debt actually becomes short-term. If interim reports are not made public, however, this adjustment between accounts can be done at the end of the fiscal year.
This distinction is important when assessing the overall financial health of a company because short and long term items on the Balance Sheet are often compared. There are commonly used ratios that test liquidity, leverage, and strength of a company using either short- or long-term debt, or both. These include:
- Current Ratio measures liquidity by comparing Current Assets to Current Liabilities [Current Assets / Current Liabilities]
- Quick Ratio, also known as the ‘Acid Test’, is similar to the Current Ratio but eliminates Inventory from Current Assets assuming they are not as liquid as Cash and Investments [(Current Assets – Inventory) / Current Liabilities]
- Debt Ratio is a leverage indicator comparing Debt to Assets [Total Debt / Total Assets]
Debt to Equity is also a leverage yardstick; it is used to determine who owns more of the company, its shareholder or its creditors [Total Debt / Equity]. Another way to look at this ratio is that it measures how the company has been financed, either through investment and earnings or by borrowing.