More of this Feature • Part 1: Lesson 3 Main • Part 2: How to Get Statements • Part 3: What's a Balance Sheet • Part 4: Typical Balance Sheet • Part 5: Current Assets • Part 6: Receivables • Part 7: Receivable Turns • Part 8: Inventory • Part 9: Inventory Turns • Part 10: Inventory Example • Part 11: Prepaid Expenses • Part 12: Current Liabilities • Part 13: Working Capital • Part 14: WC Per Dollar of Sales • Part 15: Negative Work. Cap • Part 16: Current Ratio • Part 17: Quick Ratio • Part 18: Long Term Investment • Part 19: Property, Plant, Equip. • Part 20: Intangible Assets • Part 21: Goodwill • Part 22: Deferred Charges • Part 23: Debt, Debt to Equity • Part 24: Other Liabilities • Part 25: Minority Interest • Part 26: Shareholder Equity • Part 27: Book Value • Part 28: Com. & Pref. Shares • Part 29: Cap. Surplus, Reserve • Part 30: Treasury Stock • Part 31: Retained Earnings • Part 32: Formula & Calculations • Part 33: Putting it all Together • Part 34: Segment 2

Related Resources • Investing Lesson 1 • Investing Lesson 2 • Investing Lesson 3 • More Investing Lessons

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Long Term Debt

The amount of long term debt on a company's balance sheet is crucial.  It refers to money the company owes that it doesn't expect to pay off in the next year.  Long term debt consists of things such as mortgages on corporate buildings and / or land, as well as business loans.

A great sign of prosperity is when a balance sheet shows the amount of long term debt has been decreasing for one or more years.  When debt shrinks and cash increases, the balance sheet is said to be "improving".  When it's the other way around, it is said to be "deteriorating".  Companies with too much long term debt will find themselves overwhelmed with interest payments, a risk of having too little working capital, and ultimately, bankruptcy.  Thankfully, there is a financial tool that can tell you if a business has borrowed too much money.

Debt to Equity Ratio

The Debt to Equity Ratio measures how much money a company should safely be able to borrow over long periods of time.  It does this by comparing the company's total debt (including short term and long term obligations) and dividing it by the amount of owner's equity (which is explained in part 23.  For now, you only need to know that the number can be found at the bottom of the balance sheet.  You'll actually calculate the debt to equity ratio in segment two when we look at real balance sheets.)

The result you get after dividing debt by equity is the percentage of the company that is indebted (or "leveraged").  The normal level of debt to equity has changed over time, and depends on both economic factors and society's general feeling towards credit.  Generally, any company that has a debt to equity ratio of over 40 to 50% should be looked at more carefully to make sure there are no liquidity problems.  If you find the company's working capital, and current / quick ratios drastically low, this is is a sign of serious financial weakness.

Profitable Borrowing

If a business can earn a higher rate of return than the interest rate at which it borrows, it becomes profitable for the business to borrow money.  (An example: If a corporation earned 15% on its investments and borrowed funds at 8%, it would make 7% on the borrowed money [15% return - 8% cost of money = 7% net profit].  This boosts what analysts call "Return on Equity".  We will talk about Return on Equity, or ROE, in a future lesson.  It is briefly touched on in the Retained Earnings section of this lesson.)

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