Net debt, a figure that describes the current outstanding liabilities of a firm, is used by managers to asses the solvency of a company both in the present and in the future. In seeking to make projections moving forward, managers may aim for a "flat" net debt projection, in which the firm takes on more debt only to the extent that it can offset that debt with cash on hand or cash equivalents in an effort not to worsen the financial situation of the firm.
Net Debt Defined
Net debt is one of several figures and ratios used by managers to estimate and quantify their current business position. Specifically, net debt is equal to total liabilities and debt outstanding, minus any cash or cash equivalents. From an accounting perspective, this relates to the balance sheet and items on the balance sheet. The word "liabilities" is simply an accounting term for debt, or any entries on the balance sheet that are debt and, as such, quantify money that must be paid back to another party. "Cash equivalents" are things that can be easily turned into cash without high transaction costs, such as short-term bonds or money market funds, rather than other assets that may be salable but whose sale takes longer and may be subject to more transaction costs, such as factories, land and equipment.
Net Debt's Importance and other Debt Ratios
Net debt is important as an indicator of the firm's financial health. Compared with companies with relatively low net debt, companies with relatively high net debt face the prospect of more financial risk. That is because if the debt comes due unexpectedly or if cash runs short for debt payments, the company will be unable to pay off the debt and may face insolvency (or, in more layman's terms, bankruptcy and the end of the company). Along with net debt, other figures and ratios can provide more detailed information about the company's current position and future solvency for managers.
Types of Debt Ratios
Net debt is one of many debt figures and ratios that attempt to give managers an idea of the business's current position and possible future solvency. Other debt figures and ratios include the debt ratio (total debt divided by total assets), the "acid test" or quick ratio (cash plus marketable securities plus accounts receivable, divided by current liabilities), the debt-to-equity ratio (total debt divided by total equity), and others. These ratios attempt to describe a company's current position, and most debt ratios attempt to say something about the firm's solvency or ability to make payments on their debts.
Flat Net Debt and "Flat" Projections
Managers may make goals or projections for "flat" net debt, which is simply keeping the figure of net debt at its current level, or possibly reducing it, for the next fiscal period. By aiming for a flat projection, managers implicitly recognize the firm is unlikely to be able to pay off its liabilities in the near future but are seeking to resist the urge to finance more expansion (or even current operating costs) by borrowing. In any figure or ratio, a "flat" projection, or reports after the fact of the figure/ratio being "flat", simply means no change in the figure or ratio.
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