What Is Funded Debt? Definition & Meaning

KEY TAKEAWAYS

• Funded debt is debt that takes a period of time more than one year or one business cycle to mature
• The funded debt to EBITDA ratio is found by dividing the funded debt by the current business earnings before interest taxes depreciation and amortization.
• Funded debt comes in the form of bonds with fixed maturity dates of over a year, convertible bonds, debentures, mortgages, and long-term notes payable.

What Is a Funded Debt?

Funded debt is also referred to as long-term debt. This type of debt takes a prolonged period of longer than one year or one business cycle to reach maturity. It’s called funded debt because the loan is being funded through interest payments made by the borrowing company over the full loan term. 

The funds from this type of corporate debt are used to finance a variety of long-term projects such as

• Expanding operations
• Research and development
• Opening new locations
• Launching new product lines

It’s not limited to just these options though. It could be used for other business activities and company needs that it can’t afford right now. Since the borrowing company can lock in a fixed interest rate on the financing, it’s considered to be a relatively safe form of debt financing. 

Some examples of funded debt instruments include: 

• Bonds with fixed maturity dates of over a year
• Convertible bonds
• Debentures
• Long-term notes payable
• Mortgages 

Unlike equity financing, the company isn’t selling shares to raise capital. Instead, it issues debt in the form of bonds or applies for financing through a bank. The interest being paid on the debt then becomes income for investors and lenders. In some cases, funded debt is calculated as a business’s long-term liabilities less shareholder’s equity.

Funded Debt to EBITDA Ratio

The funded debt to EBITDA ratio measures a company’s ability to meet its funded debt obligations with its earnings ahead of its other obligations which include

• Interest
• Taxes
• Depreciation
• Amortization

Also referred to as Earnings Before Interest Taxes, Depreciation, and Amortization (EBITDA). If the ratio is too high, it suggests that the company is overly leveraged and may not be able to meet the financial requirements of its current plus future debts. 

A lower ratio is more ideal since it indicates that the firm has sufficient funds to meet its debt repayment obligations as they come due. Many times a ratio below three is considered to be a safe choice. Ratios above three often raise alarms depending on the industry you’re in. In some sectors, it’s common to hold more debt. In practice the calculation for the ratio is done through the following formula: 

To better understand how to use this ratio, let’s go over a quick example. Let’s say that ABC Corporation has the following financials: 

• EBITDA: $80,000
• Long-term Debt: $150,000

Plugging it into the formula would give us this result: 

150,000/80,000=1.875

A 1.875 ratio would mean that the company is capable of paying its funded debts and may be able to take on additional debt obligations.

Similar to the debt to income ratio used in personal finance, the funded debt to EBITDA ratio is used by credit rating agencies and lending institutions to determine whether or not a business should be approved for additional credit. So if your business needs additional financing, it’s important to keep this ratio at a healthy level to avoid added risk. 

Funded vs Unfunded Debt

We already know that funded debt is any financial obligation that has a maturity date of more than one year or a business cycle. It comes with a fixed maturity date, bears interest, and is considered to be long-term debt. 

Unfunded debt is the opposite of that. It’s a short-term debt that is due in a year or less. It’s used to cover more immediate financial obligations and is usually issued in the form of 

• Treasury bills that mature in less than a year
• Corporate bonds that mature in under a year
• Short-term bank loans

When the government has funded debt they establish a separate fund for the repayment of the debt load. For unfunded debt, there’s no fund established for repayment. 

Unfunded debts are typically used when a company is having trouble covering its daily operational expenses with the current cash flow. While this allows for more flexible financing, it does pose an interest rate and refinancing risk.

Summary

Overall, funded debt is considered a safer financing option for businesses since the full repayment of the debt takes longer than a year to mature. These long-term debts are funded through interest payments across the loan term and can be used to cover a wide variety of business projects. In comparison to funded debt, short term or unfunded debt reaches maturity in a year or less and is used to cover more day-to-day expenses.