Current Portion of Long-Term Debt
The total amount of long-term debt to be paid off in the current year.
What Is The Current Portion Of Long-Term Debt?
The total amount of long-term debt to be paid off in the current year is the current portion of long-term debt recorded on the balance sheet.
Creditors and investors look at a company's balance sheet to evaluate if it has enough cash on hand to pay off its short-term obligations. They use the current portion of long-term debt (CPLTD) statistics to make this assessment.
To determine if the company can actually make its payments when they are due, interested parties compare this sum to the company's present cash and cash equivalents.
A business that has a sizable CPLTD and little cash is more likely to go into default—that is, to stop making payments on schedule on its debts. Lenders might opt not to extend more credit to the business as a result, and shareholders might elect to sell their shares.
For example, let us say a company has a total of $500,000 due to its long-term creditors, out of which $50,000 is due to be paid off this year, then the company would record $450,000 as long-term debt, and the remaining $50,000 as current portion of long term debt.
The current portion of long-term debt (CPLTD) is an essential metric as investors, creditors, and other stakeholders often use it to determine the firm's ability to pay its short-term obligations.
Thus lenders might not want to lend funds to the company, and the equity owners would sell their shares, ultimately reducing the company's market value.
Key Takeaways
- The current portion of long-term debt (CPLTD) is the portion of total long-term debt due to be paid off within the current year.
- It is recorded on a company's balance sheet and is a crucial metric for creditors, investors, and stakeholders evaluating the company's ability to meet short-term obligations.
- The division between long-term debt and CPLTD helps stakeholders assess a company's liquidity. High CPLTD and low cash balance may indicate a risk of default, affecting the company's ability to raise funds through debt.
- Payments made for a specific year are recorded by debiting the long-term debt account and crediting the current portion of the long-term debt account.
Current Debt vs. Long-Term Debt
Companies generally classify liabilities as long-term or short-term liabilities. Those payments that the company has to make within the current year are known as current liabilities.
Some examples of the current liabilities include,
- creditors
- accounts payable
- notes payable
- current portion of long-term debt
- interest payables
- wages payables
- bonds payable (within 12-months)
- short-term loans, etc.
Long-term liabilities are those of a company whose payment must be made over more than one year.
Therefore, when long-term debt payments become due in the current year, they are classified as current liabilities and recorded as the current portion of long-term debt on the balance sheet.
However, suppose a company does not want CPLTD on its balance sheet. In that case, it can raise funds through an instrument that allows it to make balloon payments at the end of the tenure of the loan, that is, making only interest payments during the tenure and paying the full loan amount at the end of the tenure.
As the CPLTD is the principal payment for the loan in a balloon payment loan option, the accrued principal payments are paid in one go during the end of the tenure, so there would be no CPLTD recorded on the balance sheet.
Businesses use balloon payment loans for various reasons; it reduces the current liabilities, improves the firm's liquidity ratios, and also allows firms to reduce their payment burdens and increase their net profits.
In certain cases, long-term debt can be automatically converted into current debt. For example, if the loan indenture contains a covenant about the call of the entire loan due on account of default in payment, in such a case, long-term debt automatically becomes a CPLTD.
How to record the CPLTD?
To demonstrate how companies record long-term debt, let us assume a company takes a loan of $500,000 to be payable in 20 years. Now, the company debits the bank account with $500,000 and credits the long-term debt with the same amount.
The company would transfer a part of the loan outstanding each year to the current liabilities section of the balance sheet at the beginning of every year.
Now, if the company needs to make payments of $25,000 for a particular year, then it would debit a long-term debt account and credit the CPLTD account.
As the company makes the payments, it credits its bank account with an amount equal to the payment made and debits the current portion of the long-term debt account.
This division between long-term debt and CPLTD helps in understanding the company precisely for the stakeholders interested in the liquidity of the company.
The company might also not be able to raise funds through debt if it has a high CPLTD along with a meager cash balance which would indicate to the stakeholders that the company is at a high risk of default which also increases the required return of the equity investors as well leading to plummeting of the company's stock price too.
Current Portion Of Long-Term Debt FAQs
The companies having high amounts of fixed assets and long-term debt have a high CPLTD and often look like they have a working capital crunch; these companies can also sometimes report a negative working capital.
Yes, CPLTD consists of only principal payments. Interest is recorded as an expense in the profit and loss statement and will not be recorded in the balance sheet as it is not part of the debt taken.
Accounts payable are a company's borrowings that it has to pay within one year, whereas the current portion of long-term debt is that of long-term debt that is due in one year.
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