Debt, in a balance sheet, is the sum of money borrowed and is due to be paid. Calculating debt from a simple balance sheet is a cake walk. All you need to do is to add the values of long-term liabilities (loans) and current liabilities.
Debt = Long Term Liabilities + Current Liabilities.
Long-term liabilities are the liabilities whose due dates for repayment is spread over more than one financial year. Current liabilities are the liabilities which are due within a period of less than one financial year.
Current liabilities includes creditors balances, outstanding expenses, short term loans and advances, bank overdraft/cash credit, provision for taxation, proposed dividend, unclaimed dividend etc. It also includes all kinds of employee’s accrued salaries and wages payable, taxes payable, unearned revenues, advances received from customers, interest payable, etc. This list can be made as long as possible. The best way is to understand the concept/definition of current liabilities and try to apply to all the items which are part of a trial balance or balance sheet.
Why calculating debt is important?
Debt is a very sensitive area on the balance sheet. It is very rare to find the business without debt. If I wish to define debt in a different manner, I can say debt is an arrangement whereby entrepreneurs without possessing money, does business. Long term and short term debt are provided by financial institutions and banks whereas short-term interest-free financing is provided by the creditors/accounts payable of any business. Both these parties assess the credibility, capacity, and willingness to pay and also assess the genuine requirement of the business for loans or any type of credit.
There are various ratios involving debt such as current ratio, quick ratio, debt ratio, debt-equity ratio, capital gearing ratio, debt service coverage ratio (DSCR). These ratios are used by various different parties for different purposes. Debt should not be understood in its absolute terms. Debt has different meanings with the different purpose.
For example, debt service coverage ratio is worked out by the banks to assess the future cash flow and its ability to pay the installment. Here, the debt is understood to be the debt given by the institutions. In current ratio, only the current liabilities are utilized to assess the short-term liquidity position of a business.