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Good debt versus bad debt: maturity, cost and coverage

Debt is not a quantity you judge by size. The same balance can be comfortable or fatal depending on when it comes due, what it costs, and whether the business generates enough to service it. Those three questions are answerable from published filings.

Written under the standing byline R. Devlin screening and filings Published

Questions
3
Where the terms live
the notes
Total debt alone
uninformative
Two coils of thin steel wire on dark board, one wound tight and even, the other loose and tangled
The same length of wire, wound two ways. Debt is judged by its terms, not its total.

Question one: when does it come due?

A maturity schedule is the single most useful debt disclosure and it lives in the notes rather than on the balance sheet, which shows only a current and non-current split. The schedule sets out how much falls due in each of the coming years, and a concentration in one year is a refinancing event the business has to survive.

This is what separates comfortable leverage from fragile leverage more than any ratio. A company with debt spread evenly over ten years and one with the same amount due in eighteen months are in different situations, and the balance sheet totals are identical.

Question two: what does it cost, and is that fixed?

A row of brass padlocks of graduated size threaded on a chain across dark board, the largest hanging open
A covenant is the open one. It converts a gradual deterioration into a single dated event.

Fixed-rate debt has a known cost for its life. Floating-rate debt is repriced against a reference rate, so its cost changes without the company doing anything. In a rising-rate environment a floating book becomes more expensive on existing borrowing, which is a mechanical effect rather than a management decision.

The interest expense line gives the historical cost, but the notes give the structure: fixed against floating, the reference rate, any hedging, and the covenants attached. Covenants are the part with teeth. A breach can make debt immediately repayable regardless of the maturity schedule, which is how a solvent business can face a liquidity crisis.

The line that turns a schedule into a cliffA covenant is a promise about a ratio: leverage below a level, coverage above one. It converts a gradual deterioration into a sudden event, because breaching it can accelerate the whole balance. Any assessment of debt that has not looked for covenants has assessed the timetable and missed the trigger.

Question three: does the business cover it?

Interest coverage is operating profit divided by interest expense, and it answers how many times over the current earnings pay the current interest. A coverage of 8 is comfortable; a coverage near 1 means almost all operating profit is servicing debt and any deterioration is immediately a problem.

Net debt to EBITDA compares the balance with annual operating cash generation and is the ratio most covenants are written on. Both are crude and both are useful precisely because they are crude: they compare an obligation with the capacity to meet it, which is the actual question. Neither replaces the maturity schedule, because a company can cover its interest comfortably and still be unable to repay a principal balance falling due at once.

When borrowing is the productive choice

Debt that funds assets generating more than it costs is straightforwardly productive, and refusing it would be the error. Debt is also genuinely cheaper than equity for a stable business, because a lender takes less risk than an owner and interest is generally deductible while dividends are not. A company with no debt is not automatically better run.

Borrowing turns unproductive when it funds operating losses, when it is used to buy back stock at a high price, or when the maturity profile is shorter than the payback of what it funded. The reliable pattern is the mismatch: borrowing short to fund long. That is the shape of the failures, and it is visible in the schedule rather than in the total.

FAQ

Questions this page raises

Is a debt-free company always safer?

Not always. Zero debt removes refinancing and covenant risk, and it also means the business is funded entirely by the most expensive capital available. Whether that is prudence or under-investment depends on what it could have earned on borrowed money, which is a business question rather than a balance-sheet one.

What debt-to-equity ratio is acceptable?

There is no general answer, and any single figure is wrong somewhere. Utilities and property businesses with predictable cash flows carry leverage that would be reckless for a cyclical manufacturer. Coverage and the maturity profile travel better across industries than the ratio does.

Where do I find the maturity schedule?

In the debt note of the annual filing, usually as a table of amounts falling due in each of the next five years plus a total thereafter. It is not on the face of the balance sheet, which is why it is skipped so often.

Does the Altman Z-Score capture this?

Partly, through working capital and retained earnings, but it uses balance-sheet totals rather than terms. A company with a dangerous maturity concentration can score in the safe zone because the formula has no input for when the debt is due.

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