Balance Sheet – Liabilities

Liabilities are amounts of money that a company owes to others. They can include all kinds of obligations, such as money borrowed from a bank to launch a new product, rent for the use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future. A Liability is something that will result in, directly or indirectly, less cash in the future. To qualify as a liability, the following requirements must be met:

  • They must be measurable
  • Their occurrence is probable

Liabilities are generally listed based on their due dates. Liabilities are said to be either current or long-term. 

  1. Current liabilities are obligations a company expects to pay off within the year.
  2. Noncurrent / Long-term liabilities are obligations due more than one year away.

Current Liabilities

Current liabilities are obligations that have a maturity date that is less than one year or one business cycle away.

Trade and Other Payables

Trade Payables / Accounts Payable

Accounts payable represents bills the company for goods or services that it has not yet paid for. They are the counterpart of accounts receivable, and generally investors would like to see opposing trends in this item. For example, we would prefer to see a company collect receivables as quickly as possible. However, if a company can postpone paying what it owes for a longer period of time – without getting into trouble – it will retain its cash for a longer period of time, which has a positive effect on cash flow.

Here is a good illustration of Accounts Payable.

Other Payables

Other Payables or Accrued Expenses include the following items:

  1. Salaries payable
  2. Rent
  3. Tax
  4. Utilities

Current Tax Liabilities

A tax liability is the total amount of tax that an entity is legally obligated to pay to an authority as the result of the occurrence of a taxable event.

Deferred Revenue (Unearned Revenue)

The company has collected cash in advance from customers for products/services that it has not yet delivered. It will recognize Deferred Revenue as real revenue over time as it delivers the products/services. The company must pay expenses and taxes on this revenue in the future.

Here is a good illustration of Deferred Revenue.

Short-term Borrowings

This refers to money that the company has borrowed for a term of less than one year. It is often a line of credit that can be drawn down at the discretion of the company. Generally, the proceeds are used for short-term needs. Often, the amount of long-term debt that must be repaid within one year is also included in this line item. The amount of short-term borrowings is an important indicator, especially if a company is in financial distress or pays a high dividend, as the entire amount must be repaid relatively quickly, leaving little room for manoeuvre.

Noncurrent Liabilities (Long-Term Liabilities)

Long-term liabilities are obligations that have maturities that are more than one year away.

Long-term Borrowings

This is money that the company has borrowed – usually through the issuance of bonds – and that doesn’t have to be repaid for several years. Too much long-term debt is usually risky for a company because the interest on the debt must be repaid no matter how the business performs. Determining how much debt is too much is very company-specific and depends on many factors, including the interest rate a company pays on its debt and the stability of the company’s earnings and cash flows.

Just as with cash, long-term debt should be carefully scrutinized. A company using long-term debt properly can generate value for shareholders. However, the amount of long-term debt on a company’s books should be reasonable. For example, using long-term debt to fund expansion projects provides tax deductions through interest payments and does not dilute shareholder’s equity, while allowing the company to fund profit-producing assets. The downside is that a company must be able to pay back its loans with interest. In addition, bondholders hold priority over shareholders in the event of liquidation. Once again, capital-intensive businesses require more cash, potentially leading to more long-term debt. Be sure to analyze long-term debt relative to industry norms.

Deferred Tax Liability

A company may keep two separate sets of books — one for tax purposes and one to report to shareholders. Firms may account for depreciation aggressively when preparing tax filings in order to report lower profits, and thereby owe lower taxes, to the IRS. Contrarily, companies may use less aggressive depreciation methods when reporting to shareholders, resulting in higher profits and income taxes. The difference in the income tax between the two calculations shows up as ‘deferred income tax’ under long-term liabilities.

This represents a timing difference in taxes. For some reason, the company paid less in taxes than what it owed in some earlier period, and it must make up the difference by paying more to the government in the future. The company must pay higher cash taxes in the future.

Explore other chapters and guides

Leave a Reply

Your email address will not be published. Required fields are marked *

Scroll to Top