Liability

Definition

In business and finance, a liability refers to an obligation or debt that a company owes to external parties, which can include individuals, other companies, or governmental entities.

What are liabilities?

A liability represents a claim on the company’s assets and is a crucial aspect of the company’s financial structure. Liabilities are recorded on the balance sheet and are an essential component in evaluating a company’s financial health.

Types of liabilities:

1. Current liabilities: These are obligations that are expected to be settled within one year or within the company’s normal operating cycle.
2. Non-current liabilities: These are obligations that are not expected to be settled within one year or the company’s normal operating cycle. 

Liabilities are recorded on the balance sheet, under the headings of current liabilities and non-current liabilities, depending on their expected settlement date.

They affect a company’s equity and liquidity. For example, high levels of debt can result in higher interest expenses, which can impact profitability.

Example of a liability

ABC Electronics, a small electronics retailer, plans to expand its product offerings and open a new store location to increase its market presence. To fund the expansion, ABC Electronics determines that it requires additional capital beyond its current resources. The company decides to apply for a business loan from XYZ Bank.

The bank approves a business loan of $100,000 for ABC Electronics. The business loan represents a liability for ABC Electronics. While the funds provide the necessary capital for expansion, the company is now obligated to repay the borrowed amount, along with any accrued interest, according to the terms outlined in the loan agreement.