Raising Debt

When a company raises debt, the transaction appears only in the Cash Flows from Financing Activities section because it doesn’t affect the company’s taxes. When the company repays debt principal, the repayment appears only in the Cash Flows from Financing Activities section.

However, the interest expense that the company pays on that debt is reported in the Income Statement because the interest expense affects the company’s taxes.

Taking on debt increases the company’s cash balance. Think about what happens when you take out a student loan: You’ve to pay it back in the future, but right now you’ve more cash to pay tuition.

To sustain business growth of our business, we raised 10-year bank loan for total $50,000.00. We will repay $5,000.00 the debt every year, and the bank will charge us 3.5% interest rate per annum.

We raised 10-year bank loan for total 50,000.00, so we must record this in Cash flows from financing activities. We repaid 5,000.00 in Year 2. We also have to record this in Cash flows from financing activities.

Cash Flow StatementYear 1Year 2
Cash flows from operating activities
Net Income28,804.0051,034.00
(Gains) / Losses on disposal of quoted shares0.00(1,000.00)
Changes in working capital
(Increase)/Decrease in Inventory0.00(22,000.00)
(Increase)/Decrease in Accounts Receivable0.00(45,000.00)
(Increase)/Decrease in Prepaid Expenses0.00(16,000.00)
Increase/(Decrease) in Accounts Payable0.004,000.00
Increase/(Decrease) in Deferred Revenue0.0011,500.00
Net cash from operating activities28,804.00(11,466.00)
Cash flows from investing activities
Capital Expenditures0.00(18,000.00)
Acquisition of quoted shares0.00(10,000.00)
Disposal of quoted shares0.0011,000.00
Net cash from investing activities0.00(17,000.00)
Cash flows from financing activities
Proceeds from bank borrowings0.0050,000.00
Repayment of bank borrowings0.00(5,000.00)
Net Cash from financing activities0.0045,000.00
Net Change in Cash28,804.0016,534.00

Bank loan is a liability. When we received $50,000.00 in our bank account, we have to record $50,000.00 in the Balance Sheet. We repaid $5,000.00 in Year 2. Therefore, ending balance of bank loan: $45,000.00 = $50,000.00 – $5,000.00.

Balance SheetYear 1Year 2
Current Assets
Accounts Receivable0.0045,000.00
Prepaid Expenses0.0016,000.00
Short-Term Investments0.000.00
Total Current Assets30,000.00129,534.00
Long Term Assets
Property, plant and equipment0.0012,000.00
Total Long Term Assets0.0012,000.00
Total Assets30,000.00141,534.00
Liabilities & Equity
Current Liabilities
Accounts Payable0.004,000.00
Deferred Revenue0.0011,500.00
Total Current Liabilities0.0015,500.00
Long Term Liabilities
Total Long Term Liabilities0.0045,000.00
Toal Liabilities0.0060,500.00
Total Liabilities & Equity30,000.00141,534.00

The interest expense we paid on that debt shows up on its Income Statement: $1,750.00 = $50,000.00 x 3.5%.

Income StatementYear 1Year 2
Cost of Sales(110,000.00)(150,000.00)
Gross Profit90,000.00130,000.00
Selling and marketing expenses(3,000.00)(7,000.00)
Administrative expenses(50,000.00)(50,000.00)
Operating Expenses(53,000.00)(57,000.00)
Operating Profit37,000.0067,000.00
Other Income / (Expenses)900.00900.00
Interest Income / (Expenses)0.00(1,750.00)
Gains / (Losses) on disposal of quoted shares0.001,000.00
Profit Before Tax37,900.0067,150.00
Income tax expense (24%)(9,096.00)(16,116.00)
Net Income28,804.0051,034.00

Impact of Raising Debt to the Financial Statements in a Glance

Impact of Raising Debt to the Financial Statements in a Glance

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