Determining the Pre-Tax Expense of Accumulated Debt

Determining the Pre-Tax Expense of Debt Clarification

Many organizations rack up debt to fund their operations, whether through bank loans or by offering bonds in the public credit market. For investors, it's essential to understand how much a company has to shell out in interest to keep their debt at bay. Frequently, firms will disclose the whole sum of interest they had to shell out on their debt, but sometimes, what you'll find on a financial statement is the net interest, less the value of the tax reduction the company received from its debt repayments. In such instances, you'll need to determine the company's pre-tax debt cost to get a comprehensive understanding of their financial status. Here are three methods to achieve that goal:

Examine the Remaining Debt

Take a Gander at the Remaining Debt

Many companies provide a thorough breakdown of their outstanding bonds and long-term debt in the financial declarations they are required to share every quarter. By scrutinizing the details of these debt securities, you can calculate the interest the company incurred for each.

For instance, if a company has a $100 million bond issue with an interest rate of 5%, it will pay out $100 million times 5% or $5 million annually on the debt. If you apply the same formula to each outstanding debt issue, you can add up the totals to get a comprehensive figure for the company as a whole.

Focus on the Cash Flow Statement

Pay Attention to the Cash Flow Statement

Some companies will use post-tax metrics on their income declarations while displaying pre-tax money movements related to interest expense on their cash flow statements. If that's the case, you might spot an adjustment on the cash flow statement related to interest expense. Add the adjustment to the post-tax measure, and you'll have your pre-tax figure.

Use the Overall Effective Tax Rate

Deploy the Overall Effective Tax Rate

Even if the company doesn't provide you with all the necessary details to calculate the pre-tax debt cost directly, you can still arrive at a back-end number by considering the company's overall effective tax rate. Begin with subtracting the tax rate from 1, and then divide the post-tax cost of debt by the result. That should give you a sufficient estimate of the pre-tax cost of debt, although since it relies on average effective tax rates rather than the company's marginal tax rate, it might not be entirely accurate in reflecting the true debt costs involved.

Figuring a Percentage Post-Tax Cost of Debt

Determining a Percentage Post-Tax Cost of Debt

These methods will give you a total dollar amount that the company is paying in interest. At times, though, you might want to know the cost of debt to calculate a cost of capital ratio. To accomplish this, simply divide the pre-tax cost of debt by total outstanding debt. That will yield a percentage that indicates the average interest rate the company paid on its debt that year.

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Debt plays a key role in how many companies function, but understanding the interest you're paying on that debt is paramount. Calculating the pre-tax debt cost can provide you with valuable insight when evaluating a company.

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To get a comprehensive understanding of a company's financial status, you might need to determine the pre-tax debt cost, which can be calculated by adding up the interest paid on each outstanding debt issue, as detailed in the financial declarations.
If a company only provides a net interest figure on its financial statement, you can use the overall effective tax rate to estimate the pre-tax cost of debt by subtracting the tax rate from 1, and then dividing the post-tax cost of debt by the result.