The term short-term debt to long-term debt ratio refers to a measure that allows the investor-analyst to understand the proportion of debt that is coming due in the near term. The short-term debt to long-term debt ratio can indicate a problem rolling shorter term debt forward into longer term debt.
Short Term Debt to Long Term Debt Ratio = Current Liabilities / Noncurrent Liabilities
Liquidity measures allow the investor-analyst to understand the company's long term viability in terms of fiscal health. This is usually assessed by examining balance sheet items such as accounts receivable, use of inventory, accounts payable, and short-term liabilities. One of the ways to understand the overall liquidity position of a company is by calculating their short term debt to long term debt ratio.
The short term debt to long term debt ratio provides the investor-analyst, and lenders, with information in terms of the ability of a company to roll current liabilities into longer term debt. This metric is typically examined over time to determine if the company is having trouble convincing lenders it has the ability to repay debt due in the long term. This metric should be examined along with cash flow since improving cash flow performance will counteract a decline in this metric over time.
The manager of a large mutual fund would like to understand the ability of Company ABC to secure long term loans from lenders. Company ABC has demonstrated problems producing sufficient cash flow in the past and the fund manager would like to better understand the long term viability of Company ABC. The manager asked his analytical team to gather information from Company ABC's balance sheet over the last several years to examine this metric's pattern. The information found by his team appears in the table below:
|Year 1||Year 2||Year 3|
|Short Term Debt to Long Term Debt||0.61||0.59||0.60|
Based on this information, the fund manager concluded that despite a decline in cash flow performance, Company ABC was still on favorable terms with lenders.