5.5. Ignoring Debt and Liquidity
Lesson objective
Avoid underestimating obligations.
During favorable periods, debt may appear manageable. When revenue falls or interest rates rise, debt reduces flexibility and may force a company to issue shares or sell assets.
Current Ratio or cash alone do not show maturity schedules and covenants. Review the notes and the calendar of obligations.
Different businesses can support different debt levels depending on stability and asset quality.
Debt is a claim on future cash flow
Debt is not automatically bad. It becomes dangerous when future cash generation is insufficient, volatile, or poorly timed relative to obligations.
Useful starting measures:
Net Debt = Total Debt − Cash
Net Debt / EBITDA = Net Debt ÷ EBITDA
Interest Coverage ≈ EBIT ÷ Interest Expense
Ask when, not only how much
| Question | Why it matters | |---|---| | When does debt mature? | Refinancing may occur at worse rates | | Is the rate fixed or floating? | Interest expense may change rapidly | | Are there covenants? | Financial flexibility can shrink under stress | | How cyclical is cash flow? | Debt is harder to service during a downturn | | What liquidity is available? | Cash and credit capacity buy time |
A maturity can matter more than the headline debt number
Two companies each owe $2 billion. Company A has ample cash and maturities spread over ten years. Company B has little cash and $1.5 billion due next year. The debt total is the same, but refinancing and liquidity risk are very different.
Always read leverage together with cash-flow stability, maturity schedule, liquidity, and interest cost.
What you should remember
- The balance sheet matters before a crisis becomes visible.
Practice
Write a stress scenario that includes lower FCF and an upcoming debt maturity.