Current portion of long-term debt is the amount of long-term debt that must be paid within the next 12 months. Companies use accounting practices to simplify budget preparation and ensure timely payment to avoid damaging credit ratings. Long-term debt is segregated into long-term and short-term debt on the balance sheet. Maintaining this accounting process helps compare long-term debt with cash flow, and potential creditors consider the balance between cash flow and current debt when assessing credit risk.
A current portion of long-term debt is that amount of long-term debt obligations that must be paid off within the next twelve-month period. Many companies use standard accounting practices to qualify this portion of long-term debt, a process that simplifies the preparation of achievable annual budgets. The idea behind identifying the current portion of long-term debt is to make sure that budgets are arranged so that the debt can be paid within the terms that relate to that debt. This in turn allows the company to avoid running into delays and possibly damaging the company’s credit rating.
While methods vary somewhat, the basic means of accounting for the current long-term debt position is to include what is known as a liability section on the company’s balance sheet. Within this section, bonds are segregated into long-term debt and short-term debt. Long-term debt is anything that is scheduled to be paid longer than the next twelve months, while short-term debt includes all obligations that are expected to be paid within the next twelve months. As the payments on each of the open debt obligations roll over that twelve-month time frame, that amount is deducted from long-term debt and moved to the short-term debt subset in the liabilities section. This means that the realignment of the current share of long-term debt is an ongoing process and often updated at least monthly.
Maintaining this type of accounting process makes it much easier to compare the long-term debt portion with current cash and cash equivalents that the business can use to retire the debt in a timely manner. Assuming that there is sufficient cash flow to meet current payments due on outstanding debt, the firm is able to move forward without any real impediments to meeting its obligations. If cash flow trends indicate that the level of that regular cash inflow will fall below the amount needed to properly manage current debt, steps can be taken to reduce costs or otherwise generate funds so that such obligations are still satisfied according to the terms. This allows you to get through a slow business season without hurting your company’s credit or your relationship with any of your current creditors.
Potential creditors will often take a close look at the relationship between the share of long-term debt held by a company and the amount of free cash flow enjoyed by the current business. Higher current debt, coupled with relatively little cash flow, is a sign that the business may not pose good credit risk, as the default potential is slightly higher. Investors sometimes consider this same factor and avoid investing in an asset where the balance between cash flow and the current portion of long-term debt is considered unfavourable.
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