Debt is money a business owes and must repay, usually with interest, under a contract: bank loans, overdrafts, bonds, director's loans and finance leases are all debt. In the accounts it is a liability split between amounts falling due within one year and after more than one year, and for tax a company can normally deduct the interest, subject for large groups to the corporate interest restriction, which only bites above a £2 million annual de minimis.
Debt in a business context
The defining feature of debt is a contractual obligation: the borrower must pay interest and repay the principal on the agreed dates, whatever its profits. That is what separates it from equity, where shareholders have no right to a dividend or to have their money returned while the company continues.
The obligation, not the label, decides the classification. HMRC's Corporate Finance Manual gives the example of a preference share that is mandatorily redeemable on a set date: because the company has a contractual obligation to pay, it is a financial liability, not equity, even though it is legally a share.
Types of debt
- Secured debt. The lender takes a charge over assets, such as a mortgage over property or a debenture over the whole business, and can enforce it if the borrower defaults. A charge created by a company must be delivered to Companies House within 21 days beginning with the day after it was created, or it is void against a liquidator, an administrator and other creditors;
- Unsecured debt. No assets are pledged, so the lender relies on the borrower's credit standing, and often on a personal guarantee from the directors;
- Short-term debt. Overdrafts, revolving credit and trade finance, used for working capital and usually repayable within a year;
- Long-term debt. Term loans, commercial mortgages and bonds, used to fund assets and growth over several years;
- Trade creditors. Amounts owed to suppliers are also liabilities in the balance sheet, but they are not borrowings and carry no interest unless paid late.
Debt versus equity
| Point | Debt | Equity |
|---|---|---|
| Return to the provider | Contractual interest | Dividends at the directors' discretion, plus growth in value |
| Repayment | On agreed dates | Generally only on a sale, buyback or winding up |
| Control | No ownership, but covenants can restrict the business | Shareholders own the company and may vote |
| Ranking on insolvency | Ahead of shareholders | Last |
| Corporation Tax | Interest normally deductible | Dividends not deductible |
Gearing: measuring how much debt a business carries
Gearing compares debt with equity. Two common versions are:
- Debt to equity. Total borrowings divided by shareholders' funds;
- Debt to capital. Total borrowings divided by borrowings plus shareholders' funds.
A company with £400,000 of borrowings and £600,000 of shareholders' funds has debt to equity of 67% and debt to capital of 40%. There is no statutory "safe" level. Lenders set their own limits in covenants, often alongside interest cover (profit before interest divided by interest), and high gearing magnifies both returns and losses. Our guide to debt advisory explains how a business can test the market beyond its own bank.
How debt appears in the accounts
The Companies Act balance sheet formats show bank loans and overdrafts (and, in the formats for larger companies, debenture loans) under "Creditors: amounts falling due within one year" and "Creditors: amounts falling due after more than one year". The notes must also disclose, for each item under creditors, the aggregate amount of any debts "in respect of which any security has been given by the company" and the nature and form of that security, and the amounts falling due after more than five years.
Under FRS 102, a basic loan is initially measured at the transaction price including transaction costs and then at amortised cost using the effective interest method. In practice, arrangement fees are not expensed on day one but spread over the loan's life as part of the interest charge. Our effective interest rate calculator shows how fees change the true rate.
Tax relief for interest
- Companies. Under the loan relationships rules, debits on a loan taken for the trade, including interest, "are treated as expenses of the trade which are deductible in calculating those profits";
- Sole traders and partnerships. For trading profits, "interest is an item of a revenue nature, whatever the nature of the loan", so business loan interest is deductible under the normal rules;
- Dividends. In contrast, "no deduction is allowed in respect of a dividend or other distribution";
- Large groups. The corporate interest restriction caps net interest deductions broadly at 30% of tax-EBITDA, but every group can deduct up to £2 million of net interest a year, so most SMEs are unaffected. Our guide to the corporate interest restriction covers the calculation.
Budget 2026 announced a technical change to the corporate interest restriction: from 1 January 2027, Audio-Visual and Video Games Expenditure Credits will be excluded from the taxable earnings figure used in the calculation, to be legislated in Finance Bill 2026-27.
Worked example: what debt costs after tax
A company pays the 25% main rate of Corporation Tax and needs £400,000. It compares a bank loan at an illustrative 8% interest with issuing shares to an investor who expects an equivalent £32,000 a year in dividends.
- Loan. Interest of £400,000 × 8% = £32,000 is deductible, saving £32,000 × 25% = £8,000 of Corporation Tax, so the after-tax cost is £24,000;
- Equity. £32,000 of dividends is paid out of taxed profit and saves no Corporation Tax, so the cost is the full £32,000;
- The catch. The interest is due every year whether or not the company makes a profit, and the £400,000 must be repaid; the dividend can be cut when trading is poor.
The deduction is worth 19% rather than 25% where profits are at or below £50,000, and an effective 26.5% in the marginal relief band between £50,000 and £250,000, which is why the cost of debt varies between companies even at the same rate. Where a director lends to the company, the same rules apply, as our guide to lending money to your own company explains.
Primary sources: SI 2008/409 and SI 2008/410 Schedule 1, Companies Act 2006 s859A and s859H, HMRC's Corporate Finance Manual at CFM23040 and CFM21120, CTA 2009 s297, CTA 2009 s1305, ITTOIA 2005 s29, TIOPA 2010 s392 and Budget 2026.
If you need loans presented and disclosed correctly, our FRS 102 accounts team can help, and our Corporation Tax advisers can check how much of your interest is deductible.