Definition of Book Value of Debt
Book Value of Debt refers to the total amount which the company owes to the others i.e., the amount payable by the company, comprising of the Notes payable amount, long-term debt, and the current portion of the long-term debt where the value of these items is present in the balance sheet of the company and it does not include accrued liabilities and the accounts payable.
Explanation
Book value of the debt refers to the value of Notes payable amount, long-term debt, and the current portion of the long-term debt as per the balance sheet of the company. While deriving at the b.v of the debt, the market value of any of the components is not considered. It is one of the important measurements for calculating the liquidity ratios of the company where this value is compared with the cash flows or the assets to know the capability of the organization for supporting its debt.
Example of Book Value of Debt
For example, there is a company named ADLTrading, whose balance sheet shows the following balances as of 31 March 2020:
Balance Sheet of ADL ltd As of 31st march 2020
| Particulars | Amount ($) |
| Liabilities and Shareholder’s Equity | |
| Shareholder’s Equity | |
| Equity Capital | 500,000.00 |
| Retained earnings | 60,000.00 |
| Total shareholder’s equity | 560,000.00 |
| Non -current Liabilities | |
| Long term debt | 56,600.00 |
| Total Non -current Liabilities | 56,600.00 |
| Current Liabilities | |
| Accounts Payable | 15,000.00 |
| Notes payable | 14,000.00 |
| Current portion of the long-term debt | 25,000.00 |
| Total Current Liabilities | 54,000.00 |
| Total shareholder’s equity and liabilities | 670,600.00 |
| Assets | |
| Non-Current Assets | |
| Land | 515,000.00 |
| Property and Equipment | 106,000.00 |
| Total Non -current Assets | 621,000.00 |
| Current Assets | |
| Cash and Cash Equivalents | 25,600.00 |
| Accounts receivable | 6,800.00 |
| Inventory | 17,200.00 |
| Total Current Assets | 49,600.00 |
| Total Assets | 670,600.00 |
Calculate the B.V of debt.
Solution:
Book Value of Debt = Notes Payable + Long Term Debt + Current Portion of the Long Term Debt
- B.V of Debt = 14,000 + 56,600 + 25,000
- B.V of Debt = $95,600
Book Value of Debt vs Market Value of Debt
The difference between the B.V of the debt or market value of debt is provided and discussed below-
- Market value of debt is the value at which the investors of the company are ready to buy the debt whereas on the other side, the B.V of the debt is the value of debt calculated as per the value present in the balance sheet of the company
- It is easier to calculate the B.V of debt as all the values are already present in the balance sheet and one just has to add the value of all the components that are to be considered while calculating the book value of debt whereas on the other side it is comparatively difficult to calculate the market value of debt because all the debts are not publically traded like in case of bank loan as they do not trade in the market and also their value tends to change from time to time due to the inflation factors, for the debt which is not publicly traded, it is difficult to calculate their market values.
How to Find Book Value of Debt?
B.V of the Debt can be calculated using the below-mentioned formula:
Notes Payable + Long Term Debt + Current Portion of the Long Term Debt
Balance sheet of every company is divided into three sections i.e., the equity section, the liabilities section, and the assets section. The value of these items as required for the purpose of calculating the B.V of the debt can be found on the liabilities side of the balance sheet of the company. Sub categorization of these items is:
- Notes payable, are the written promissory notes which do not earn interest. These are listed under the head current liabilities of the liabilities section.
- Long-term debt refers to the debt which is repayable after the one-year period and they are listed in the balance sheet’s long-term liabilities section
- The current portion of long-term debt refers to the part of the long-term debt which is due for repayment in the next year only and since they are repayable within one year so they ate listed under the head current liabilities of the liabilities section.
Advantages
The advantages of the B.V of debt are provided and discussed as below:
- While calculating liquidity ratios in the company, book value is used mostly where the same is used in order to see whether the organization is capable enough for supporting its debt or not, by comparing it other with the Assets of the company or cash flows for the company and the analysis can be made accordingly by the management of the company.
- It is easier for the company to calculate the B.V of date using the formula mentioned as the value of all the components is available in the balance sheet of the company and so the value can be derived just by adding these components that include notes payable long term liabilities and current portion of the long term liabilities one can calculate the book value of debt.
- The market value of debt changes as per the market situations prevailing at a particular point of time whereas the book value changes in case when there is any updation in the financial statements by the company only so, the calculation using the book value of debt gives the actual value of amount company owes to the others as recorded in the books of accounts of the company
Disadvantage
The disadvantages of the book value of debt are provided and discussed as below:
- The book value of debt does not provide the actual net value of the debt considering the market value of those components prevailing at the time. So in order to find out the exact net position of the debt in the company one has to calculate the market value of the debt
- The book value of debt changes periodically by the company either quarterly, annually, or monthly as decided by the management of the company. So in order to know the exact updated value of debt, one has to wait for the Updation of those financial statements.
Conclusion
Thus, the Book value of the debt comprises three components that include notes payable amount, long-term debt, and the current portion of the long-term debt. This Book value is available on the company’s Balance Sheet under the Long Term Liability head and Current liability head as the case may be. It is one of the useful measurements for the liquidity ratios of the company and also it is easier to calculate book value when compared to the market value of debt.
Recommended Articles
This is a guide to the Book Value of Debt. Here we also discuss the definition and how to find the book value of debt? along with advantages and disadvantages. You may also have a look at the following articles to learn more –
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