Funded Debt: Overview and Types in Corporate Accounting

Key takeaways
* Funded debt (long-term debt) comprises a company’s interest-bearing obligations that mature beyond one year or beyond the normal operating cycle.
* Common examples: bonds with maturities >1 year, convertible bonds, long-term notes payable, and debentures.
* Analysts assess funded debt via ratios such as the capitalization ratio and funded-debt-to-net-working-capital to evaluate leverage and solvency risk.
* Debt financing preserves ownership and may provide tax-deductible interest, while equity financing dilutes ownership but avoids repayment obligations.

What is funded debt?
Funded debt refers to a company’s long-term, interest-bearing obligations that mature in more than 12 months (or beyond the company’s operating cycle). It appears on the balance sheet as part of long-term liabilities and typically requires periodic interest payments to creditors.

Common examples
* Bonds with maturity dates exceeding one year
* Convertible bonds
* Long-term notes payable
* Debentures

Funded vs. unfunded (short-term) debt
* Funded debt: Long-term borrowings with maturities beyond one year. Interest rates can often be locked in for longer periods, reducing rollover risk.
* Unfunded debt: Short-term obligations due within one year (e.g., short-term bank loans, commercial paper, bonds maturing within a year). Short-term financing can offer flexibility but increases exposure to interest-rate and refinancing risk.

How analysts evaluate funded debt
* Capitalization ratio (cap ratio): long-term debt / (long-term debt + shareholders’ equity). A higher ratio indicates greater financial leverage and potentially higher insolvency risk, though industry norms and tax benefits of debt affect interpretation.
* Funded debt to net working capital: funded debt / net working capital. A ratio below 1 is generally preferred, indicating long-term debt does not exceed the firm’s short-term liquid capital, but ideal levels vary by industry.

Debt funding vs. equity funding
Advantages of debt financing:
* Retains ownership and control (no new shareholders).
* Interest payments are generally tax-deductible, lowering after-tax cost of capital.

Disadvantages of debt financing:
* Repayment and interest obligations can strain cash flow and increase insolvency risk if not managed.

Advantages of equity financing:
* No mandatory repayments; less cash-flow pressure.
* Can provide permanent capital for growth.

Disadvantages of equity financing:
* Dilution of ownership and potential loss of control.
* Dividends are not tax-deductible.

Practical considerations
* Industry norms, business cycle, and the firm’s cash-flow profile determine an appropriate funded-debt level.
* A balanced capital structure often combines funded debt for tax-efficient financing with equity to maintain financial flexibility and reduce default risk.

Conclusion
Funded debt is a core component of corporate capital structure, representing longer-term borrowing secured through interest-bearing instruments. Understanding its types, risks, and how it interacts with equity is essential for assessing a company’s leverage, solvency, and financing strategy.