Is now the time to Convert Short-Term Debt to Long-Term Debt?
Converting short-term floating rate debt into long-term fixed rate debt can improve the working capital of your business, which can be utilized to take advantage of opportunities or to grow your business.
When short-term floating rates approximate fixed long-term rates, there is little if any incremental interest expense resulting from opting for long-term fixed rates over short-term floating rates for your business.
Long-term fixed rates would provide your business an effective hedge against potential increases in interest rates in the future.
Converting short-term debt into long-term debt would improve the liquidity and working capital of your business without adversely impacting the leverage ratios of your business. Higher long-term debt, however, would increase the debt service requirements of your business.
Case Illustration
To view the numbers for the case illustration click here.
ABC Co. ("ABC" or the Company") had a fully utilized $5 million operating line that was constraining the day-to-day operations and growth of its business.
ABC management and its trusted advisors undertook a refinancing to convert $4 million of its operating line into long-term debt.
The balance sheet and selected financial statistics and ratios are presented for ABC for both before and after the refinancing. In the illustration, $4 million of the $5 million operating line was refinanced with long-term debt repayable in equal annual principal payments over 10 years at a 5% interest rate. The long-term debt was adequately secured by the Company’s capital assets. The refinancing improved ABC’s working capital by $3.6 million and improved the Company’s working capital ratio from 1.13x to 1.65x. The refinancing had no impact on ABC’s balance sheet leverage ratios. ABC had sufficient operating cash flows available to service the incremental increase of $400,000 in debt service requirements (representing principal repayments on long term debt) attributable to the refinancing (EBITDA to Debt Service decreased from 2.50x to 2.08x).
To view our firm's Financing experience click here.
Claude Conan, CA, CPA, CBV, MBA (Founder and President of Quantum Advisory Inc.) can be reached by telephone at 780.669.9724 or email at claude.conan@quantumadvisory.ca.