Debt forms a good chunk of the liabilities on a company's balance sheet. The book value of debt represents the amount of outstanding notes, loans and bonds that the company owes to vendors, creditors and investors. Creditors compare the book value of debt to other factors, like assets and equity, to decide whether to issue a loan.
Financing and Debt
Businesses have two primary options for financing. They can exchange equity for cash or get financing through loans. The latter is considered debt. When a company takes on debt, the cash account is increased by the amount of the loan and a liability account is created to account for the debt. The company will incur and record interest expense every month as it pays back the principle of the loan.
Calculating Book Value of Debt
For accounting and finance purposes, book value of debt is considered to be the sum of notes payable, the current portion of long-term debt and remaining long-term debt. Notes payable and the current portion of long-term debt can be found in the current liabilities section of the balance sheet, which is listed after noncurrent assets. Long-term debt can be found in the noncurrent liabilities section of the balance sheet, which is listed directly underneath current liabilities. A few other short-term liabilities accounts -- including accounts payable -- typically are listed on the balance sheet, Accounts payable and other short-term liabilities are typically not included in the total book value of debt.
Understanding Book Value of Debt
The book value of debt is the amount that a company owes its creditors. Investors and other creditors scrutinize this figure carefully when deciding whether to invest in or loan money to a company. If the book value of debt is too high compared to available assets, the company may have trouble paying back new loans. For this reason, creditors often look at a company's debt ratio -- liabilities divided by assets -- when considering the rate at which to lend. More debt means a higher interest rate or possibly no loan at all.
The book value of debt is commonly used to calculate a company's weighted average cost of capital. This is primarily calculated by financial analysts to determine the average cost a company spends to obtain financing from all sources. To remain profitable, the company will only invest in projects that exceed its current cost of capital. Weighted average cost of capital is calculated by multiplying the weight of equity by the cost of equity and adding it to the weight of debt and the cost of debt. The weight of debt is calculated by dividing the book value of debt by the total market value of equity plus the book value of debt. For example, a company that has a $100,000 book value of debt and equity with a market value of $100,000 has a 0.5 weight of debt. If the cost equity is 4 percent and debt is 6 percent, the weighted average cost of capital is 5 percent.
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