How a business term loan shows up on your balance sheet

At funding, two entries. Cash increases by the amount that actually reached the account. A liability is recorded for the principal owed. If a fee was deducted at closing, the cash figure is the net amount while the liability is generally the face amount, with the difference treated as a financing cost.

The liability is then split across two lines:

Illustrative only — a $150,000 loan, 60 months, fixed 9.5% nominal rate, payment $3,150.28. Principal repaid in the first twelve months is $24,606.45. So at closing the balance sheet shows $24,606 as current portion and $125,394 as long-term.

Roll forward a year. The balance is $125,393.55, and the principal falling due in the next twelve months is $27,048.58. The current portion has grown even though the total debt has shrunk, because the principal component of every payment increases as the loan amortises.

That has a consequence people notice and misdiagnose: the current portion rising each year pushes current liabilities up, which pushes the current ratio and working capital down, with no change in the business at all. If you have a covenant tested on current ratio or working capital, model it across the whole loan term, not just at closing.

What each payment does

Take month one on the same loan. The payment is $3,150.28: interest of $1,187.50 and principal of $1,962.78.

• Cash falls $3,150.28
• Loan liability falls $1,962.78
• Interest expense of $1,187.50 hits the income statement

Only $1,187.50 of that $3,150.28 reduced profit. The remaining $1,962.78 left the bank and never appeared on the P&L. Across the first year, $37,803 of payments produced $13,197 of expense and $24,606 of invisible cash outflow. That difference is the single most common reason a profitable business finds itself short of cash. See working capital.

The current ratio drift, year by year

The point is easier to see as a series than as a sentence. Illustrative only — keep the same $150,000 loan and assume current assets of $220,000 and other current liabilities of $90,000 that never move.

• At closing: current portion $24,606, current liabilities $114,606, current ratio 1.92.
• End of year one: current portion $27,049, current liabilities $117,049, current ratio 1.88.
• End of year two: current portion $29,733, current liabilities $119,733, current ratio 1.84.
• End of year three: current portion $32,684, current liabilities $122,684, current ratio 1.79.

The business is identical in all four rows. It sold the same amount, collected the same way, carried the same payables. The only thing that changed is that a loan amortised, which is what loans do.

A covenant set at a 1.85 minimum current ratio passes at closing and fails at the end of year two, on arithmetic that was fully knowable on the day it was signed. That is the modelling exercise to do before you accept a ratio covenant: build the amortisation schedule, roll the current portion forward for every year of the term, and see where the covenant crosses.

Details that change the presentation

What lenders do with it

An analyst reading your balance sheet reconciles the current portion of long-term debt against the debt schedule you supplied, and against the recurring debits in the bank statements. Three sources that agree make a clean file. Three that disagree generate questions before anything else gets looked at, so it is worth reconciling them yourself before you send anything.

Building the debt schedule a lender will accept

A debt schedule is the document that connects the three records an analyst reconciles, and most owners hand over a version that raises questions instead of closing them. One row per obligation, with these columns:

1. Lender or holder, exactly as named on the agreement.
2. Original amount and date.
3. Current balance as at the balance sheet date.
4. Payment amount and frequency, stated as it actually leaves the account — daily, weekly, semi-monthly, monthly.
5. Rate or cost measure, labelled as what it is. A factor rate is not a rate and should not be entered in a rate column.
6. Maturity date.
7. Collateral and whether personally guaranteed.

Then run the reconciliation yourself. The sum of the current balances should tie to the balance sheet. The sum of the monthly payments should tie to the recurring debits in the bank statements. If they do not, the difference is either an obligation missing from the schedule or a debit that is not debt, and either way you want to be the person who explains it first.

Where a daily-debit product breaks the picture

A merchant cash advance is documented as a purchase of future receivables rather than a loan, and how it should be presented is a question for your accountant and turns on the substance of the agreement rather than on its label. What is not in doubt is the cash flow: the debits leave the operating account every banking day, exactly like debt service, whatever line they end up on.

Two practical consequences. An analyst will find those debits in the bank statements whether or not they appear on the balance sheet, and a schedule that omits them looks like concealment rather than accounting judgment — so list them, with the amount, frequency and remaining balance. And any ratio you calculate for yourself will overstate the health of the business if the obligation is not in the denominator. Compute debt service coverage with the advance debits included, because that is the version your next lender will compute.