Debt Types: Secured, Unsecured, Senior and Subordinated Compared

Business borrowing varies along two axes that are often confused. Security is about whether a specific asset backs the loan. Ranking is about who is paid first if there is not enough to go round. A loan can be unsecured and senior, or secured and subordinated, and knowing one says nothing about the other. Maturity is a third, separate question, and it is the one the balance sheet actually presents.

Here is what sits underneath that. Three different people wrote three different promises into three different documents, and each of those promises answers a different question. The first asks what happens to one named machine if the money is not repaid. The second asks, when several lenders are all waiting and there is not enough for all of them, whose turn comes first. The third asks simply when the money is due back. Nothing forces those three answers to line up, and the whole art of reading a borrowings note is refusing to let one of them stand in for another.

The balance sheet splits everything it carries into current and non-current, a lease creates a liability just as a loan does, and collateral and covenants are words lenders use. Those three facts, put into one grid, describe any borrowing by four separate statements: whether an asset stands behind it, where it sits in the queue, when it falls due, and where in a set of accounts the answer is found. Anjani Stationers Private Limited, an invented notebook maker, carries three borrowings and one guarantee, and each of them is placed against those four statements.

What kinds of borrowing does a business actually carry?

Most confusion about debt is really confusion about which instrument is being discussed, so start with the map. Five kinds cover almost everything an ordinary trading or manufacturing business will carry, and they exist for genuinely different reasons rather than as variations on a theme.

A term loan is a fixed amount lent for a fixed period and repaid on a schedule. The loan funds something specific and long-lived, usually a machine, a shed or a vehicle. A working capital facility, of which cash creditA working capital facility with a sanctioned ceiling. The borrower draws and repays freely up to that ceiling and is charged on what is actually drawn rather than on the whole limit. and overdraft are the common Indian forms, is not an amount at all but a ceiling. The business draws what it needs, repays when money comes in, and draws again. Debentures and bonds are borrowings raised from many lenders at once rather than one, evidenced by an instrument that can usually be transferred. A lease liability arises when a business takes the use of an asset over time and commits to a stream of payments for it. And inter-company borrowing is money lent by a holding entity, a subsidiary or a person connected to the business, on terms that may look nothing like a bank's.

Anjani Stationers carries three of the five, being a term loan, a lease liability and a cash credit facility, and the one that never appears on its year-end balance sheet is the one that generated most of its interest.

What does secured actually mean, and what does the security do?

Secured debtBorrowing that has a specific asset standing behind it, so that if the borrower fails to pay, that asset can be sold and the proceeds go to this lender before anyone else. is borrowing with a named asset standing behind it. The lender registers a chargeA right registered over a specific asset which allows the holder to have the asset sold and to take the proceeds ahead of other claimants. First charge and second charge describe the order in which two such rights are satisfied. over that asset, and the charge does exactly one thing: if the borrower fails to pay, the asset can be sold and the proceeds go to that lender before they go to anyone else. Unsecured debtBorrowing with no specific asset behind it. The lender relies on the borrower's general ability to pay and, if that fails, joins the general queue of claimants. is borrowing with no such asset behind it. The lender relies on the business as a whole.

Think about a household taking a loan against a plot of land it already has. Nothing about that loan makes the monthly payment more likely to arrive. The salary that pays it is the same salary. The mortgage changes what happens on the day the salary stops. The lender already holds a right over one specific thing, so it does not have to argue with everyone else about who gets what. Security changes recovery, not repayment, and a secured lender is not more likely to be paid on time; it is better placed if paying stops.

The distinction between recovery and repayment matters more than it looks. It is the reason security is a poor proxy for safety. A charge over a highly specialised machine that only three businesses in the country can use is a charge over something that may fetch very little at a forced sale. A charge over stock of school notebooks in July is a charge over something worth a great deal less in October. The value of security is the value of the asset on the worst possible day, not on the day the loan was signed, and a reader who treats every secured borrowing as protected has quietly assumed a market that may not be there.

What is the difference between senior and subordinated debt?

Ranking answers a different question altogether: not what can be sold, but whose turn it is. Senior debtBorrowing that is paid before other borrowing out of whatever money is available. Being senior says nothing about whether an asset stands behind the loan. is paid before other borrowing out of whatever there is. Subordinated debtBorrowing whose lender has agreed in writing to be paid only after certain other lenders have been paid in full. The agreement is what creates the ranking, not the absence of security. is borrowing whose lender has signed a document agreeing to wait until the senior lenders are paid in full. Nobody is subordinated by accident. Somebody signed a deed.

The everyday version is a household with three creditors and one month's salary. The landlord, the school and a cousin who lent money last year all want paying. If the cousin has said, quite explicitly, that he will take his money only after the rent and the fees are settled, he is subordinated. He is subordinated whether or not he is holding the household's gold as security, and the household holding his gold would not move him up the queue by a single day. Security determines what a lender can reach; ranking determines when a lender may reach it, and one of those facts never implies the other.

Which is why the grid below matters more than any list. Every one of its four cells exists in ordinary lending. The cell readers find hardest is the secured and subordinated one, and it is entirely commonplace: a second charge over the same machine, sitting behind a first charge, held by a lender who has agreed to rank second. The two facts were never connected, so the second charge holder has real security and is still last in line.

How do Anjani Stationers' own borrowings map onto all of this?

A map is only useful once something is placed on it, so now put Anjani Stationers on the grid. Anjani Stationers has three borrowings and one item that looks like a fourth and is not.

The term loan of Rs 4,20,000 carries a first charge over the binding machinery it helped pay for, so it is secured and senior. The cash credit facility is secured by a charge over stock and receivables, the ordinary shape of a working capital facility, and it too is senior. The lessor keeps title to the leased asset and needs no charge, so the lease liability of Rs 6,00,000 has no registered charge and ranks alongside the general claims on the business.

All three of Anjani Stationers' borrowings crowd into the same corner of the grid. For a business of its size that is entirely ordinary, and it is exactly why the four-cell grid needed examples from elsewhere to fill it. A small manufacturer borrows from one bank against the things it has, and nobody has yet asked anyone to sign a deed agreeing to wait. The other three cells appear as a business gets larger, takes on more lenders at once, and has to arrange them in an order.

Then the item that is not a borrowing. Anjani Stationers has given a guarantee over Rs 8,00,000 of borrowing taken by Chitra Binding Works, its seventy per cent held subsidiary. The guarantee is disclosed and not recognised. It appears in the notes and not in any liability total. Anjani Stationers has received no money and, unless Chitra Binding fails to pay, will never owe any, so the guarantee is not a borrowing of Anjani Stationers. A guarantee is a promise that becomes a liability only if something else happens first, and it is the last thing a reader should let quietly join the debt figure.

Debt Maturity Classification: what test decides current from non-current?

The third axis is the one the balance sheet actually presents, and it is the simplest of the three. The test is when the obligation falls due, measured from the reporting date, and the ordinary dividing line for presentation is twelve months. Anything the business must settle within twelve months of that date is current; anything it has an unconditional right to defer beyond twelve months is non-current. The questions the test leaves out matter as much. The test does not ask how long the loan originally ran, what it was called, who lent it, or whether an asset stands behind it. The test asks one question about dates.

Work it on Anjani Stationers' lease. The lease liability is Rs 6,00,000, of which Rs 2,00,000 falls due within the year. The balance sheet therefore carries Rs 2,00,000 as a current liability and Rs 4,00,000 as a non-current one, and the two lines add back to the single obligation of Rs 6,00,000. That Rs 2,00,000 is the lease's current maturityThe part of a long-term borrowing that falls due within the next twelve months. The part due within twelve months is presented among the current liabilities even though the borrowing as a whole is long-term., and current maturities are where a great deal of next year's cash requirement quietly lives.

The same loan is split across two lines of the balance sheet, and the split is a statement about dates rather than about the loan. Which produces the trap. A five-year loan that has behaved impeccably for four years enters its final twelve months, and on the next reporting date its entire remaining balance moves from non-current to current. Nothing about the loan has changed. No term was renegotiated, no covenant was tested, no payment was missed. The calendar moved and the presentation followed it. A reader watching only the non-current borrowings line would see it fall to nil and could easily conclude the business had repaid something, when in fact the money is more urgently owed than it has ever been.

Short-Term Debt vs Long-Term Debt: what really separates them?

Short and long borrowing are not the same instrument on different clocks. The two exist for different jobs, and mixing them up is where real damage happens.

Short-term borrowing funds the gap between paying for something and being paid for it. Anjani Stationers prints notebooks in the months before a school session, pays for paper and labour immediately, and then waits about 128 days for schools and distributors to pay. The facility exists to cover exactly that wait, and it is a revolving facilityA facility the borrower can draw down, repay and draw again as often as needed within its sanctioned ceiling, rather than a single amount lent once and repaid on a schedule., meaning it is drawn and repaid and drawn again as the season turns. Long-term borrowing funds something that will earn over years. A term loan against a binding machine is repaid out of what the machine produces over its life, so the schedule is stretched across years rather than months.

The second difference is structural rather than a matter of price. A facility is charged on what has been drawn, so a business pays for the money it is actually using and frequently pays a separate charge on the part of the ceiling it has left alone. A term loan is charged on the whole outstanding balance whether or not the money is doing anything useful that month. The relative cost of short and long borrowing is a market fact that moves constantly. Anjani Stationers' contracted rates happen to sit at the same level on both instruments, so price drops out of the comparison altogether.

The third difference is the one that actually bites. A term loan does not have to be renewed. A facility does, and renewal is a decision somebody else makes, once a year, on their own view of the business at that moment. The danger is never the short instrument itself. The danger is the mismatch: a ten-year machine funded with money that has to be re-agreed every twelve months. A household feels this instinctively. Nobody funds a house on a loan from a cousin who might want his money back in March. The house lasts thirty years and the cousin's patience lasts one, and the gap between those two numbers is where the trouble sits.

Where does each kind of borrowing appear in a filing?

Everything above is invisible on the face of a balance sheet. The face gives borrowings, split current and non-current, under financial liabilities, and lease liabilities shown separately. Two or three lines, four numbers, and not one word about who lent the money, what stands behind it, when it falls due or what the business promised in order to get it.

The borrowings note carries all of that. The note sets out each facility and loan separately, the security given against each, the repayment schedule, the rate, the sanctioned limits where a facility exists, and any default or breach during the year. The face of a balance sheet states almost nothing about a business's debt and the note states nearly everything. Every question raised so far is answered in the note or not at all.

Anjani Stationers' own cash flow statement quietly confirms one piece of the picture, and it is worth following because it is arithmetic rather than assertion. Financing activities were an outflow of Rs 4,30,000 for the year. Of that, Rs 3,50,000 was interest paid and Rs 1,00,000 was lease principal repaid. Together those come to Rs 4,50,000. The actual outflow was only Rs 4,30,000, so the business must have taken in Rs 20,000 of net new borrowing. Net new borrowing of Rs 20,000 is precisely why a term loan that opened the year at Rs 4,00,000 closes it at Rs 4,20,000. Nothing there was chosen. The published statements force it.

What does a year-end borrowing figure not show?

Anjani Stationers' balance sheet shows Rs 10,20,000 of borrowings on the reporting date. Across the year as a whole, the business carried about Rs 37,00,000, being the facility's average drawing of about Rs 26,40,000 plus roughly Rs 10,60,000 of term loan and lease. The average is about three and a half times the year-end figure, and both numbers are entirely correct.

The reason is the season. Anjani Stationers prints and dispatches ahead of a school session, pays for paper and labour before any of it sells, and then waits about 128 days to be paid. The facility is drawn hard through that stretch, peaks near Rs 45,00,000 before the session begins, and falls steadily as collections arrive, reaching nil well before the reporting date. Clearing the facility before the reporting date is not a manoeuvre. A working capital facility exists for exactly that, and a business that never cleared its facility would be the one worth asking about.

The year-end borrowing figure measured one day, and one day is all it ever claimed to measure. The evidence sits in plain view in the income statement. Of the Rs 3,50,000 of finance cost for the year, Rs 2,64,000 relates to the cash credit facility, Rs 41,000 to the term loan and Rs 45,000 to the lease. The facility that reads nil on the balance sheet generated about three quarters of the year's interest. A reader who takes the borrowings figure at face value and then wonders why the interest looks so large against it has been handed the answer by the accounts themselves, in the very next statement.

Three readings from the panel carry the point. On the school-supply season, a reporting date in March gives borrowings of Rs 10,20,000 and a date in May gives Rs 55,20,000 on the identical trading year, a difference of Rs 45,00,000 produced by nothing but the choice of day. On the steady year-round trade the same March date still gives Rs 10,20,000, and that business never draws more than Rs 28,80,000, so the highest any date reaches is Rs 39,00,000. On the late-winter season, March again gives Rs 10,20,000 while November and December give Rs 55,20,000. All three businesses average exactly Rs 26,40,000 of drawing and all three report identical year-end borrowings. No cleaner demonstration exists that a single date carries no information about the shape of the year behind it.

Who reads a borrowings note, and what do they do with it?

Leave the mechanism for a moment. Three different people open the same note in the same week, and none of them is admiring the classification.

A lender reads the note to find the maximum drawn and the sanctioned ceilings, an analyst reads it to find out what the ranking and security actually are before comparing anything, and Vaidehi Rao reads the current maturities because that line is next year's cash requirement with a date on it. Watch each of them work. The lender's question is about capacity: if this business already runs a ceiling of a certain size and touched Rs 45,00,000 against it during the season, then the amount of genuinely spare borrowing capacity is a very different number from the one the balance sheet suggested. The lender also wants the security position. A first charge already sitting over the binding machinery means the next lender is looking at a second charge or at nothing.

The analyst's use is comparison, and the first move is refusing to compare until the notes have been read on both sides. Two notebook makers can show identical borrowings and be in completely different positions, one funded by a ten-year term loan agreed once and the other by a facility that three people have to agree to renew every March. And Vaidehi Rao, as finance controller inside the business, has the most immediate use of all. The Rs 2,00,000 current portion of the lease is money that has to be found in the next twelve months whatever else happens, and it sits on the balance sheet alongside Rs 22,00,000 of trade payables and Rs 4,00,000 of contract liabilities that also have to be settled out of the same cash. She is not classifying anything. She is reading a calendar.

One boundary belongs here rather than in a footnote. Mapping a business's borrowings shows what the obligations are and how they are arranged; it never shows whether there are too many of them. A business with three secured senior borrowings may be perfectly comfortable or badly stretched, and nothing on the security and ranking grid separates the two. The judgement about how many is too many needs the ratios, the cash generation and the covenants, and it needs them read together.

The last two rows read against the total above them are the whole argument in one table. The facility carries the same charge and the same ranking every day of the year and contributes Rs 26,40,000 on average and nil on the one day the balance sheet looks. The guarantee carries an amount larger than most of the borrowings above it and is not a borrowing at all. Neither fact is hidden and neither fact is on the face.

Anjani Stationers Private Limited, Chitra Binding Works Private Limited and Vaidehi Rao are invented.
Educational material. Not advice on any investment, tax, budget or market position.