Off balance sheet debt: the notes are the balance sheet

A friend sent me an investor deck last week. Net debt to EBITDA of 1.2. Lightly geared, he said. Clean balance sheet. Why would you worry about this one.

So I opened the notes to the accounts. The borrowings line he was reading off turned out to be about half the company's actual claims on cash.

Here is the thing about a net-debt number. It counts borrowings. Just borrowings. But a business carries obligations that behave exactly like debt and do not sit on the borrowings line. Lease liabilities get parked under other financial liabilities. Supply-chain financing, where a bank pays the company's suppliers and the company repays the bank later, gets tucked into trade payables and looks like ordinary working capital. Guarantees and disputed tax claims live in the notes as contingent liabilities, off the face of the balance sheet entirely.

Every one of those is a fixed claim on the same cash flow. A schedule. A counterparty who gets paid before the equity holder sees a rupee. Different line, same economics.

Run the illustrative numbers. Reported net debt 1200 crore on EBITDA of 1000, so 1.2 times. Add lease liabilities of 900 and supply-chain financing of 600, both behaving like debt, and you are at 2700 crore. That is 2.7 times. Same company, same quarter, more than double the gearing once you stop reading only the line that was put in front of you. And the 1500 crore of contingent liabilities in the notes is not even in that figure yet.

None of this is hidden, to be clear. It is all disclosed, sitting in the notes a few pages back. It is just not in the one ratio the deck leads with.

The discipline is simple. Read the notes, not just the ratio. Treat a liability that behaves like debt as debt. And add it back on both companies before you call one lightly geared and the other heavy, because a business that leases its plants and one that owns them are not different by accident.

The leverage ratio is the headline. The notes are the balance sheet.

From 1.2 times to 2.7 times, line by line

Here is the same company drawn as a stack. Each bar is a claim that gets paid before shareholders do. Only the first one made it into the deck.

The contingent liabilities are a different kind of claim. A guarantee for a group company or a disputed tax demand may never be paid. But some of it often is. A simple way to stress it is to assume a share of it lands. If one third of the Rs 1,500 crore crystallises, that is Rs 500 crore more, and the ratio goes from 2.7 to 3.2 times.

Why leases belong in the debt figure

Since 1 April 2019, Indian companies on Ind AS follow Ind AS 116, which the Ministry of Corporate Affairs notified on 30 March 2019. A company that leases a plant, a store or an aircraft now records a lease liability, the present value of the payments it has committed to, and a matching right of use asset. The rent no longer runs through operating expenses. It shows up as depreciation on the asset and interest on the liability.

That has a side effect on the ratio. Because rent is no longer an operating cost, EBITDA is higher than it would have been before 2019. So the EBITDA in the deck already gives the company credit for leasing. If you take that higher EBITDA and leave the lease liability out of debt, you have counted the benefit and skipped the obligation. Either add the leases to debt, as above, or take the lease payments back out of EBITDA and leave the leases out. Mixing the two is the error.

Where each claim sits in the annual report

Supply chain financing is the hardest of the three to spot, because it looks like a supplier being patient. A useful test is payable days. If trade payables jump from 60 days to 120 days in a year while suppliers are known to want cash in 60, someone is funding the gap, and that someone is usually a lender.

1. Borrowings noteLong term and short term borrowings, less cash and investments. This is the deck's net debt.
2. Leases noteLease liabilities, current and non current, often shown under other financial liabilities.
3. Trade payables noteLook for supplier finance or acceptances, and compare payable days with the past three years.
4. Contingent liabilities noteGuarantees given, claims not acknowledged as debt, and disputed tax demands, with the amounts.

All four notes sit in the annual report filed on NSE and BSE, and the same four checks work on every company you compare. The free Learn module on leverage, debt and financial risk works through net debt, coverage and these add backs with a quiz at the end. The post on promoter pledging covers a different claim that never appears on the company's balance sheet at all: debt the owner has taken against his shares.