How Does the Current Portion of Long-term Debt Affect Cash Flow Statement?

Companies obtain finance from various sources. Usually, this finance comes from equity holders, which constitutes equity finance. This finance is perpetual and can be crucial in helping companies start their operations as startups. However, as companies progress, they have more options available in meeting their financing needs. The other finance source that companies can choose is debt finance.

Debt finance comes from third parties that do not include a company’s equity holders. This finance is crucial in helping companies obtain funds through alternative sources. Usually, companies can get into debt through loans. These loans can be short- or long-term based on the needs of the underlying company. In exchange for these loans, companies must pay interest to the lender.

Debt finance involves various payments from and to the company. The primary transaction that initiates the process is the company receiving funds from a lender. Once companies obtain that finance, they must pay interest to the lender. Similarly, they must repay the principal amount. In some cases, these payments may begin after a rest period, allowing companies some time to use the funds.

Payments to and from lenders are usually through cash. Therefore, these impact a company’s cash flow statement. However, this impact may differ based on the treatment of the debt finance. Splitting that finance into non-current and current portions is also crucial. Before discussing the effect on cash flows, it is critical to understand the current portion of long-term debt.

What Is the Current Portion of Long-Term Debt?

As mentioned above, companies obtain debt to fund their operations. This debt constitutes a finance source for a company. Similarly, companies may receive these funds for a long or short time based on the intended use. Most companies obtain short-term debt to meet working capital needs. Long-term debt, in contrast, is crucial for financing strategic goals.

In accounting, short-term debt usually includes any debt finance which companies intend to use for less than 12 months. This finance falls under current liabilities and gets repaid to the lender within a year. Usually, short-term debt is more expensive than long-term debt. However, the accounting treatment is straightforward. In contrast, long-term debt may be more challenging.

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Long-term debt constitutes finance for companies that they use to fund long-term projects. Usually, companies obtain this debt to meet strategic objectives. Since equity finance is more expensive, long-term debt can offer a viable alternative. It is also more inexpensive than short-term debt, providing companies with an incentive to increase the duration. In accounting, any debt finance that lasts more than 12 months falls under non-current liabilities.

Accounting standards require companies to split the long-term debt into two portions. These include the non-current and current portions. However, it does not imply the loan becomes short-term. Instead, companies must separate any amounts from the loan, which they will repay in 12 months. Any principal repayments occurring after a year will stay under non-current liabilities. The other portion will classify as current liabilities.

The current portion of long-term debt refers to repayments occurring within 12 months. This portion represents a part of the loan that companies must repay in a year. Although the total amount for the reimbursement remains the same, the classification differs. This reclassification of long-term debt under two sections is mandatory under accounting standards. The cash flow statement treatment may also become complex.

How Does the Current Portion of Long-term Debt Affect Cash Flow Statement?

Companies prepare the cash flow statement under the indirect approach. Consequently, companies must report their cash outflows and inflow under three sections. These include cash flows from operating, investing and financing activities. Each part presents cash flows based on how they relate to a company’s activities. Usually, cash flows relating to debt and finances fall under the cash flows from financing activities.

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However, companies may include some parts of these finances in net profits. Usually, it consists of the interest that companies charge on the underlying loan or debt. This interest depends on the rate agreed with the lender when the company signs the loan contract. However, these may not constitute actual cash flows. Instead, companies charge these under the accrual concept in accounting. These items form non-cash expenses.

Companies start the cash flow statement with cash flows from operating activities. In this section, they must remove the impact of the interest charged. Once they do so, they can reclassify the amount under cash flows from operating activities. After removing non-cash items from operating activities, companies must adjust other amounts. These amounts include the difference between various items within current assets and liabilities.

Since the current portion of long-term debt falls under current liabilities, companies may adjust them under that section. However, that process does not apply to these debts. As mentioned above, the current portion of liabilities reclassifies the long-term debt. It only presents the amount under a different head. It does not constitute a separate item as with other titles under current liabilities.

Therefore, the current portion of long-term debt does not follow a similar treatment as other current liabilities. On top of that, treating it under cash flows from operating activities does not represent an accurate treatment. Instead, the current portion of long-term debt affects the cash flow statement through cash flows from financing activities. In this section, companies report cash flows related to the loan as a whole.

Example of Current Portion of Long-term Debt in Cash Flow Statement

As mentioned above, the current portion of long-term debt does not affect the cash flow statement. Similarly, its non-current portion does not warrant a different treatment. Instead, companies report the inflows and outflows related to the debt together. This amount falls under the cash flows from financing activities. Long-term debt usually includes both cash inflows and cash outflows.

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When a company receives long-term debt, its liabilities increase. Similarly, they receive funds from the lender. Companies must report this receipt in the cash flow statement as a cash inflow. As mentioned above, it falls under the cash flows from financing activities. For the initial transaction, the cash flow statement may report the following.

Cash flows from financing activities
Received long-term debtXXXX
Other financing activitiesXXXX / (XXXX)
Net cash flows from financing activitiesXXXX / (XXXX)

Subsequently, when the company repays the debt, it must report it as a cash outflow. It has a similar treatment as when companies receive long-term debt. However, it constitutes a cash outflow. Like the above treatment, repaying the loan also falls under cash flows from financing activities. Companies may report loan reimbursements as follows.

Cash flows from financing activities
Repaid long-term debt(XXXX)
Other financing activitiesXXXX / (XXXX)
Net cash flows from financing activitiesXXXX / (XXXX)

The above treatments only apply if the company receives or pays the loan in cash. The cash flow statement does not cover any other forms of compensation. Similarly, companies also report the interest payments related to the long-term debt under the same section. These interest payments also constitute a cash outflow in the cash flow statement.

Overall, the current portion of long-term debt does not affect the cash flow statement. Companies report any cash transactions related to that debt as a whole. As mentioned above, the current portion only presents the long-term debt under a different head. It does not alter its accounting treatment or affect the cash flow statement.

Conclusion

Companies use long-term debt to finance their strategic goals and projects. Accounting standards entail segregating this debt into current and non-current portions. However, it only constitutes a presentation change. The current portion of finance does not affect the cash flow statement consequently. Instead, companies report cash flows related to the debt as a whole. This presentation falls under cash flows from financing activities.