In financial accounting, a liability is a contractual obligation arising from past transaction or events which require delivering cash or other financial asset to another entity, provision of services, or other yielding of economic benefits in the future. In simpler words, it is something that you owe to another party. It is important to know what your financial liabilities are and to know how to properly manage them to avoid unnecessary hassle or serious dispute in the future.
Current Vs Long-term
All liabilities are recorded on a balance sheet. They could be broadly classified into two categories: current liabilities and long-term liabilities. Current liabilities are those debts that are expected to be settled in cash within then entity’s business operating cycle or fiscal year. Debtors are given a period of twelve months to settle the liabilities and must not have an unconditional right to defer payment for at least a year. Current liabilities usually include payables such as credit card debt, taxes, and any loan balances you may have. On the other hand, long-term liabilities are debts that could be paid over a longer period of time. Examples of long-term liabilities are debentures, mortgage loans, long-term bonds, long-term leases, notes payables, pension obligations, and long-term product warranties. A portion of these debts may also be classified under the current liabilities section if part of the loan will be due within the fiscal year.
Here is a closer look on other types of financial liabilities.
Accounts payable are the unpaid bills of a person or business. It is the liabilities from goods and services received, but not yet paid for. In households, accounts payable are bills from them electric company, cable television, telephone company, Internet service provider, and other regular services. In businesses, accounts payable has a broader range and accountants or bookkeeper usually utilize accounting software to track the money flow when they receive invoices or when they make payments. It involves the money the company owes to its suppliers, business partners, and its employees.
A fixed liability, also called funded debt, does not mature for at least one year from the date incurred or from a given balance-sheet. It is to be paid at the time of dissolution of firm. Examples of fixed liabilities are capital, reserve, and surplus.
A contingent liability is not an actual liability but will eventually become one depending on the outcome of a certain event. These liabilities are recorded in a company’s accounts and shown in the balance sheet only if the contingency is probable and the amount of liability can be estimated. If the contingency has a remote possibility of occurring, then it is not recorded or disclosed. Examples of contingent liabilities are outcome of a lawsuit, a government investigation, product warranties, or the threat of expropriation.
Along with financial assets, financial liabilities are considered to calculate your financial net worth. Net worth is the difference between your financial assets and financial liabilities. Hence, you should properly manage your finances in order to have more assets than liabilities. Greater financial assets generate positive net worth, and greater financial liabilities produce negative net worth. While net worth isn’t the endpoint of your overall financial being, it could provide valuable insight on how well you develop your financial assets, and how good you are in getting rid of financial liabilities. Image from www.assistedfertilityblog.com