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Liabilities

Guide to Understanding Liabilities

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Liabilities

Liabilities Definition in Accounting

Liabilities are the obligations of a company that are settled over time once economic benefits (i.e. cash payment) are transferred.

The balance sheet is one of the core financial statements and consists of three sections:

  1. Assets — The resources with economic value that can be sold for money upon liquidation and/or are anticipated to bring positive monetary benefits in the future.
  2. Liabilities — The external sources of capital used to fund asset purchases, like accounts payable, loans, deferred revenue.
  3. Shareholders’ Equity — The internal sources of capital used to fund its assets such as capital contributions by the founders and equity financing raised from outside investors.

The values listed on the balance sheet are the outstanding amounts of each account at a specific point in time — i.e. a “snapshot” of a company’s financial health, reported on a quarterly or annual basis.

Liabilities Formula

The fundamental accounting equation is shown below.

If we rearrange the formula around, we can calculate the value of liabilities from the following:

Formula
  • Total Liabilities = Total Assets – Total Shareholders’ Equity

The remaining amount is the funding left after deducting equity from the total resources (assets).

Purpose of Liabilities — Debt Example

The relationship between the three components is expressed by the fundamental accounting equation, which states that the assets of a company must have been financed somehow — i.e. the asset purchases were funded with either debt or equity.

Unlike the assets section, which consists of items considered to be cash outflows (“uses”), the liabilities section is comprised of items deemed to be cash inflows (“sources”).

The liabilities undertaken by the company should theoretically be offset by the value creation from the utilization of the purchased assets.

Along with the shareholders’ equity section, the liabilities section is one of the two main “funding” sources of companies.

For instance, debt financing — i.e. the borrowing of capital from a lender in exchange for interest expense payments and the return of principal on the date of maturity — is a liability since debt represents future payments that will reduce a company’s cash.

However, in exchange for incurring the debt capital, the company obtains sufficient cash to purchase current assets like inventory as well as make long-term investments in property, plant & equipment, or “PP&E” (i.e. capital expenditures).

Types of Liabilities on Balance Sheet

Current Liabilities

On the balance sheet, the liabilities section can be split into two components:

  1. Current Liabilities — Coming due within one year (e.g. accounts payable (A/P), accrued expenses, and short-term debt like a revolving credit facility, or “revolver”).
  2. Non-Current Liabilities — Coming due beyond one year (e.g. long-term debt, deferred revenue, and deferred income taxes).

The ordering system is based on how close the payment date is, so a liability with a near-term maturity date is going to be listed higher up in the section (and vice versa).

Listed in the table below are examples of current liabilities on the balance sheet.

Current Liabilities
Accounts Payable (A/P)
  • The owed invoices to suppliers/vendors for products and services already received
Accrued Expenses
  • The payments owed to third parties for products and services that were already received, yet the invoice has not been received to date
Short-Term Debt
  • The portion of the debt capital that is coming due within twelve months

Non-Current Liabilities

In contrast, the table below lists examples of non-current liabilities on the balance sheet.

Non-Current Liabilities
Deferred Revenue
  • The obligation to provide products/services in the future after the upfront payment (i.e. prepayment) by customers — can be either current or non-current.
Deferred Tax Liabilities (DTLs)
  • The recognized tax expense under GAAP but not yet paid due to temporary timing differences between book and tax accounting — but DTLs reverse across time.
Long-Term Lease Obligations
  • The lease obligations refer to contractual agreements where a company can lease its fixed assets (i.e. PP&E) for a specified period in exchange for regular payments.
Long-Term Debt
  • The non-current portion of a debt financing obligation that is not coming due for more than twelve months.
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