What Is Net Debt?
Net debt is the total debt minus the amount of cash and cash equivalents in the balance sheet. It is the difference between the total debt and the company's cash balance.
Net debt
Right!
- Chinese name
- Net debt
- Definition
- Minus the debt of cash and cash equivalents
- Benefit
- Tax benefits on interest payments
- Classification
- economic
- Net debt is the total debt minus the amount of cash and cash equivalents in the balance sheet. It is the difference between the total debt and the company's cash balance.
- Total debt refers to all debts issued and circulated by the company. Net debt is the difference between the total debt and the company's cash balance.
- In order to obtain the value of the company, it is usually safer to value the company based on the total debt issued and in circulation, and add the circulating cash balance to the value of the operating assets. Then, the tax benefit of debt is conferred by interest payments on total debt, and it can be estimated whether the company's investment in cash can effectively affect value.
- In some cases, especially when companies routinely maintain large cash balances, analysts tend to use net debt ratios. If you choose to use a net debt ratio, you must maintain consistency across all valuation methods. First, the company's beta should be estimated using the net debt-equity capital rather than the total debt-equity capital ratio. The cost of equity capital generated from Beta estimates can be used to estimate the cost of capital, but the market value weight of debt should be based on net debt. Once the company's cash flow is discounted using the cost of capital, cash should not be added back. Instead, the net debt issuance and circulation should be subtracted in order to give an estimate of the value of equity capital.
- Implicitly, when subtracting cash from debt to get a net debt ratio, we assume that cash and debt carry roughly similar risks. Although this assumption may be normal when analyzing highly rated companies, it becomes more vulnerable when debt is more risky. For example, the debt of a BB company is more risky than the company's cash balance, and subtracting one from the other will lead to a wrong perception of the risk of a company defaulting. Generally speaking, the net debt ratio will overestimate the value of more risky companies.
- For example, with US $ 1.25 billion of interest-bearing circulating debt issued and US $ 1 billion in cash balance, the company will have a net cash balance of US $ 250 million. The practice of subtracting cash against debt is common in Latin America and Europe, and the debt ratio is usually estimated using the net debt ratio.