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.

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.

Current vs. non-current liabilities

Current liabilities and non-current liabilities are classifications on a company’s balance sheet. Current liabilities are obligations due within one year, such as accounts payable, short-term loans, and accrued expenses. They represent the company’s immediate financial obligations.

Non-current liabilities, also known as long-term liabilities, are debts or obligations not due within the next year. Examples include long-term loans, bonds payable, and deferred tax liabilities. They indicate the company’s long-term financial commitments and are typically refinanced or paid off over a longer period.

Liabilities vs. assets

Liabilities and assets are fundamental components of a company’s balance sheet. Liabilities represent the company’s obligations or debts owed to external parties, such as creditors and lenders. They include both current liabilities, due within one year, and non-current liabilities, payable over a longer period.

In contrast, assets include everything a company owns that has economic value and can be used to generate future revenue. This includes current assets like cash, inventory, and accounts receivable, as well as non-current assets such as property, equipment, and intangible assets.

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.