Suppose your long-term debts suddenly transform into current debts one day, you might feel frantically worried about how to pay them off. You think you have preserved enough funds to pay back short-term liability by the due date. However, you need funds to pay one part of the long-term debts within the next 12 months besides the short-term liability. When you plan to make payments for your debts next year, you need to consider the so-called current portion of long-term debts (CPLTD). So, what are the current maturities of long-term debt and how to calculate CPLTD? Is there any way to reduce the CPLTD?
What are Long-term Debt and Current Maturities of Long-term Debt?
Long-term debt is simply understood as a liability that extends over one year. It usually ranges from 2 years to 20 years or even longer. In terms of financial statement reporting, enterprises must detail the issuance of long-term debt and its payment obligations in their financial statements.
Meanwhile, long-term debt investment means putting money into long-term debt that falls due in more than one year regarding the financial investment. Interestingly, long-term debt is a debt that the issuer must repay while the owners regard debt as their asset. A long-term liability is the main element stakeholders and rating agencies use to analyze and assess their companies’ liquidity risk.
In terms of financial statements, long-term debt is a type of financial obligation. It’s shown under long-term liability in a company’s balance sheet. Remarkably, unlike short-term debt (salaries for employees, office rent, trading activities, etc.), long-term debt includes business loans, bond issues (convertible bonds, bonds payable, etc.).
The current maturities of long-term debt can be simply understood as all payments regarding long-term debt. Those payments will mature in the next 12 months from the date of determination. Debtors will implement payment obligations on the ultimate maturity date of such debts.
The company’s balance sheet always lists the current maturities of long-term debt as the total amount of must-paid long-term liabilities within the current year. For example, if an enterprise owes $1,000,000 in total long-term debts in which $300,000 comes due this year, it can record $700,000 as long-term debt and $300,000 as the current portion of long-term debts (CPLTD).
Is it Necessary to Calculate the CPLTD?
The current portion of long-term debt should be calculated for creditors, investors, and analysts to evaluate whether a company has sufficient liquidity to pay its short-term obligations or not when they fall due.
For example, Borrower Inc. owes $5,000,000 with a maturity of five years. The loan terms stipulate that the company will pay an equal amount of money each year. The CPLTD now is $1,000,000 (not including interest payments).
What If the CPLTD is Overdue?
Without making any payments to long-term debts, businesses are likely to face a lot of risks. Indeed, unless the CPLTD is reduced or rolled to pay later, the banks or debtors shall apply a higher interest rate to the debt as stipulated in the borrowing contract. For example, suppose at first, the monthly interest rate is 5%. If businesses let the debt come overdue, this rate may increase from 5% to 10% as a warning for them.
More seriously, when businesses let unpaid debts pile up, shareholders and investors will withdraw investment and shares. Banks will also cut down the businesses’ credits as a warning for their inability to pay off the debts.
In the worst cases, they even have to compensate and make payments by their assets. On top of that, they may be accountable and receive penalties as promulgated in the law.
That’s why businesses should find out some ways to avoid the risks mentioned above.
For long-term debt, you can seperate it into an annual portion to pay regularly and gradually. In addition, accountants should always mention the debt in the company’s meetings or discussions. They can utilize debt schedules and analyze financial statements to plan how to cope with the CPLTD.
Another feasible way for businesses to deal with CPLTD is to reduce CPLTD. It’s considered to be a smart and safe way to suspend payments for CPLTD. Let’s learn more about the CPLTD reduction strategy in the next part!
How to Deal With the Current Portion of Long-term Debt?
First and foremost, many companies try to reduce CPLTD as early as possible if their cash positions allow. Consequently, it reduces financial stress during the year regardless of business swings since CPLTD will mature within that year. This results in an equivalent decrease in both the cash account and the payable one.
On the operational side, businesses should outline a debt schedule to keep track of all payments easily. At the end of every accounting period, accountants can base on the debt schedule to determine which long-term debt they have to pay in the next accounting period, then convert it into CPLTD in their balance sheet. From then on, they can plan the cash flow to reduce the CPLTD.
Besides, enterprises can take advantage of good credit to roll forward their current loans into long-term ones. They can utilize their good credit so that their long-term debts can be paid later. Besides, they should arrange a loan with a lower interest rate to improve their upcoming financial reports.
In short, we can understand long-term debts as debts that extend more than 1 year. Besides, the current maturities of long-term debt can span from the current date to the debt’s due date. To recognize the ability to pay short-term obligations, companies or investors need to calculate CPLTD. Also, to reduce CPLTD, businesses can convert it into long-term ones to suspend payments using more credits or taking out a loan.