Liabilities

1. Definition

Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow of resources (usually cash) from the entity.

In essence, it is a claim against the company's assets by external parties (creditors). It represents External Capital used to finance the business.

2. Classification: Maturity

Liabilities are classified based on their due date.

A. Current Liabilities

Obligations due to be settled within one year (or one operating cycle). * Accounts Payable (A/P): Money owed to suppliers for goods purchased on credit. * Accrued Expenses: Expenses incurred but not yet paid (e.g., Wages payable, Interest payable). * Short-term Debt: Loans that must be repaid soon. * Unearned Revenue: Cash received in advance from customers for goods or services not yet delivered. (It is a liability because the company owes the service).

B. Non-Current Liabilities

Long-term obligations due after one year. * Bonds Payable: Long-term debt securities issued to investors. * Long-term Debt: Bank loans with maturity dates extending beyond a year. * Pension Liabilities: Future retirement payments owed to employees.

3. Key Principles

• Obligation: A liability must be a clear duty or responsibility to act or perform in a certain way.
• Priority of Claims: In the event of liquidation, creditors (Liability holders) have priority over shareholders (Equity holders).

4. Why It Matters

• Leverage: Debt acts as leverage. If a company earns a return on assets (ROA) higher than the interest rate on its debt, shareholders earn a higher return.
• Solvency: Investors look at the Debt-to-Equity Ratio to gauge long-term solvency. Too much debt increases the risk of bankruptcy.
• Working Capital: Managing current liabilities (like delaying payments to suppliers without damaging relationships) is a key part of cash flow management.