Question

Most companies borrow money for long term projects and in addition to this long term debt they also have other long term commitments (such as a lease). What types of long term commitments might a company have and how do we gauge their ability to pay these commitments in the future?

Answer 1

Ans:- Financial Analysis and planning is carried out for the purpose of obtaining material and relevant information necessary for ascertaining the financial strengths and weaknesses of an enterprise and is necessary to analyse the data depicted in the financial statements. The main tools are Ratio Analysis, Cash Flow and Fund Flow analysis.

Long term debt consist of loans and financial obligations outstanding for more than one year. Long term debt in case of a company would include financino obligations or it many also be leasing obligations which are actually due for more than 12 months. It also applies to government because, Nation in itself also has a long term debt. Long term debt is completely different from a current liability.

In case of a company, long term commitments can be broadly classified as follows :-

1. Financial liabilities - It refers to the debt owed to the stockholders or investors. It includes bonds and Notes Payable.

2. Operating Liabilities - It includes any leases or unsettled payments incurred in order to maintain facilities or services for the company. It includes everything starting from renting out building spaces to equipment to employee pension plans.

In the detailed manner the long term commitments are classified as follows :-

1. Loans and Notes:- It means the money which the business Owes of the lender such as banks. The company may gauge their ability to pay by making periodic interest payments and repay the principal balance on a specific future date. For example :- A small business enterprises may have a $20,000, three year loan which pays down gradually with each interest payment. In the books of the company, the loan is reported as loans or notes as Notes Payable or Loan Payable in the balance sheet.

2. Bonds:- It is an instrum entry which the company sells to the investors to raise money. At one time, the company can sell multiple bonds where each bond has certain denomination such as $1000 or $2000 etc....Here the company promises to pay the periodic interest payments on the face value of the bondservices on a specific future date. For example - Your small business might issue 1 $10000 bonds to raise $10000. The company reports it as outstanding as "Bonds Payable" on its balance sheet.

3. Off Balance sheet items:- some components are not required to be reported in the balance sheet bit it should be shown as a footnotes in the balance sheet. Examples are contractual agreements and operating leases, which are agreements to lease assets that the company do not intend to own. Although these items are not present in the balance sheet, they still contribute to the balance sheet long termy debt.

4. Deferred Taxes - The amount of deferred Taxes of a company reports on this balance sheet represents the money it Owes for money income taxes. It occurs when the company's uses different methods to calculate income taxes then it gilders rise to deferred Taxes. For example:- A small enterprise might use a different Depreciation method while auditing the financial statements than on the income taxes which might create a future tax liability.

5. Capital Leases:- A lease means an agreement to use an asset such as machine in exchange to make some payments to the party who actually owns the asset. It is a lease whose characteristics are similar to making a purchase. A company treats the capital lease as if it has purchased a leased aset and reports the lease as a long term liability in the balance sheet.

These are the few above mentioned long term commitments and itso ways to gauge it's long term debt.

Most prominently bonds are one of the type of long term commitments. Companies issue bonds to raise funds for variety of reasons and it acts as a source of funding in order to raise capital for new capital projects. Ultimately sale of a bond ends up in making huge amount of income. But the company ends up paying for the investors capital due to interest payments.