What it is: Noncurrent liabilities represent liabilities which due more than one year or one operating cycle. Together with current liabilities, they make total liabilities in the balance sheet. Other names for noncurrent liabilities are long-term liabilities.
Items in current liabilities are useful for knowing the company’s solvency, which measures the ability to pay long-term obligations. Usually, the largest and most significant item in this section is long-term debt.
Noncurrent liability components
Examples of noncurrent liabilities are
- Bond payable – have a maturity of more than one year. Companies usually issue bonds to finance capital projects.
- Long-term notes payable – a special loan in which the company makes a promise unconditionally to pay back the interest plus principal to the lender and have a maturity of more than one year.
- Long-term portion of long-term debt – for example, the company has a debt IDR100 million, and approximately IDR10 million is due within one year. The company will record IDR10 million in current liabilities and the rest in this account.
- Pension obligations – future expenses or obligations associated with the pension program.
- Long-term deferred revenues (long-term unearned revenue) – emerged when the company has received a cash payment from the customer for shipment of goods or services over the next few years.
Why noncurrent liabilities matter
Long-term debt requires a lot of disclosure in financial statements. Most long-term debt is subject to various conditions and restrictions. For example, a company should manage its debt to EBITDA or debt-to-equity ratios at a healthy level. Hence, you need to check the notes on the company’s financial statements.
As leverage measure
Noncurrent liabilities are useful for measuring whether a company is using excessive leverage. The higher the interest-bearing debt (short-term debt and long-term debt) relative to assets, the higher its financial leverage, and the greater the risk. Conversely, if the percentage is low, the company uses less leverage, and the stronger its equity position is.
Other financial ratios you can use to measure leverage are debt to equity and debt to capital.
Companies may find it challenging to find new loans when they have high leverage. The default risk is high. And if they have not adequate cash flow, lenders are reluctant to lend their money to companies.
But, determining whether a company is taking on too much debt or not depends on factors such as:
- Industry norms – some industries have a high degree of leverage such as utility companies and airlines
- Interest rate the company pays to lenders
- Stability of the company’s income and cash flow
Measuring the company’s interest expense
Long-term debt, like bonds, incurs a regular interest expense. The company must pay interest or coupons regularly before maturity.
You can use the interest coverage ratio to measure a company’s ability to pay interest. For the calculation, you must divide interest expense with earnings before interest and taxes (EBIT).
Interest coverage ratio = EBIT/Interest expense
A higher ratio is more desirable because the company has a better ability to pay interest.