- Types of Liabilities
- Examples of Liabilities
Liabilities are obligations that a business owes to someone else. They are financial responsibilities that need to be settled or fulfilled over time. For example, if a company has taken a loan from a bank to expand its business, that loan is a liability because the company has to repay the borrowed money, along with an extra amount as interest.
Liabilities also include things such as bills that haven't been paid yet, wages owed to employees, or taxes that a business has to pay. These are all obligations that need to be met, and they show up on a company's financial records as liabilities.
Types of Liabilities
Liabilities generally can be categorised into three types.
Current liabilities are financial obligations or debts that a company is expected to settle within a relatively short period, usually within a year. These liabilities represent the company's short-term financial responsibilities and are crucial for understanding its ability to manage its immediate financial obligations and working capital.
A company with a healthy balance between current assets and current liabilities is better positioned to meet its short-term obligations without running into financial difficulties.
Long-term liabilities are financial obligations or debts that a company is obligated to pay over a longer period, typically extending beyond a year. Unlike current liabilities, which are expected to be settled within a short time frame, long-term liabilities represent more extended financial commitments that a company will need to address over the course of several years.
While they don't require immediate payment like current liabilities, they still impact a company's financial planning, cash flow management, and ability to invest in growth opportunities
Contingent liabilities are potential obligations or liabilities that might arise in the future, depending on certain conditions or events that are uncertain at present. These are situations where there's a possibility of the company having to pay or fulfill a responsibility, but it's not a certainty yet. Contingent liabilities might or might not materialize into actual liabilities, and the actual amount of the liability can vary. However, companies are required to disclose significant contingent liabilities in their financial statements to provide transparency to investors, analysts, and stakeholders.
Examples of Liabilities
Accounts Payable: When a company orders supplies from a vendor and receives the goods, the amount owed to the vendor is considered an accounts payable liability.
Short-Term Loans: When a business takes out a short-term loan from a bank, the loan amount, along with any interest, represents a liability that the company needs to repay.
Employee Salaries and Benefits: If a company's employees have earned salaries or benefits but haven't been paid yet, these obligations are considered liabilities until the payments are made.
Unearned Revenue: A company receives payment from a customer for a service or product that hasn't been delivered yet. The received payment is considered a liability until the service or product is provided.
Long-Term Loans: A business borrows money from a financial institution for a period extending beyond a year. The outstanding loan amount represents a long-term liability.
Deferred Tax Liability: A company recognises expenses on its financial statements differently from how it does for tax purposes. This can lead to differences in tax payable, creating a deferred tax liability.
Formula to Calculate Liabilities
- Total Liabilities = Total Assets - Total Equity
This formula considers that a company's assets are financed either by liabilities (debts) or by the owner's investment (equity)
- Current Liabilities = Accounts Payable + Short-Term Loans + Accrued Expenses + Unearned Revenue + Other Short-Term Obligations
This formula adds up all the short-term obligations that a company needs to settle within a year
- Long-Term Liabilities = Long-Term Loans + Bonds Payable + Other Long-Term Debts
This formula sums up all the obligations that extend beyond a year