Effective Debt

Posted in Finance, Accounting and Economics Terms, Total Reads: 226

Definition: Effective Debt

We understand that debt refers to the liabilities of a company in the form of bonds issued by it, to raise money.

There are 2 sources of funding for any corporate: a) Equity b) Debt

In a) company gives a percentage of its ownership to the lender and hence the lender becomes a shareholder

In b) company issues a bond, which is subscribed to, by the lender. In a normal bond, regular interest payments are there followed by principal payment at the end of maturity.

To analyse, a company’s corporate structure, we study its debt and equity and use metrics like Debt/Equity ratio etc.

Here, effective debt comes into picture. Effective debt refers to the net debt taking into account the off balance sheet liabilities of the company in the form of operating lease payments and mortgage payments .

These are rightly called off balance sheet liabilities because although being a liability to the company(co is obligated to pay these regularly), they are not capitalized(ie they are not included in the Liabilities head in the Balance Sheet). Rather they are expensed and hence are accounted for in the income statement of the company.



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