Liability is a financial obligation that is needed to pay against acquired assets for the company’s wealth. In other words, we can say that liability is the advantage by which we can move the end business forward and it is also a hindrance because without eliminating it we cannot grow in business.
Liability is of many types and they play a different role in business like wages, tax payable, salary payable is considered as an every year burden which needs to be fulfilled so that company is continuously growing without brakes, and another liability such as account payables involves loan has taken from banks are considered as an interest burden on debtors which needs to be fulfilled on time so that company does not go into debt.
What liability indicates?
Liability indicates the company’s expenses and how much the company owes. It is necessary because funds are required in every business for the settlement of assets or cash. Funds in the sense of loan which is required by the company to meet all its business requirements whether it is short-term or long-term. Liabilities are counted as essential debts owed by a business that requires to be fulfilled within a period through cash or assets. As we said that liabilities can be of many kinds but are used in different situations like
Assets are purchased from the supplier so it is a liability that we have to pay money against assets within a limited period which is counted as a short-term liability. It is recorded as an account payable under current liabilities.
Funds are issued from the banks so it is a liability that we have to pay in installments along with interest within an unlimited period (within 20 years) which is counted as a long-term liability.
We can see that both are showing debts of the company, defining the company’s financial health that they have to be liable to pay or not against debts.
- The liability shows how much the company is in the debt.
- It decides the company liquidity of the business.
Liabilities in the company alert the financial investors before any investment in the company such as when the investors think about investing in another company so they first check out their debts and survey that they are liable to pay without selling any inventories. Same as banks also have the right to check the financial paying stability through the financial ratio (debt-equity ratio or debt-assets ratio). This ratio clarifies the financial picture of the business by which investors are sure about investing and how much.
What is a liability in accounting and finance?
Liability plays a key role in accounting and finance and without which these departments are incomplete.
Under accounting, liability is a financial responsibility of a company that is required to pay against what we have adopted for the growth of the company such as goods and services, money. After becoming a debtor, we need to report in the journal books and pass entries in other financial accounts so that we are familiar with our liabilities.
Under Finance, liability is explained with many kinds such as:
Liability can be beneficial or unbeneficial for people who are involved in the finance department. The Company, Banks, and the other investors are the major role under the finance department for offering and accepting liabilities based on past events but for securing a future with economic benefits.
For example- A company issues a loan against goods or property from banks so the company is a debtor who will pay all the liabilities in the form of interest and banks are the creditor who will have to receive assets in the form of money. It is an unlimited liability that is paid after so many years, which is known as long-term liabilities.
On the other hand, a company pays wages to the employees and pays suppliers for goods or services so the company is the debtor and the supplier is the receiver. It is a liability that is paid within a year, which is known as short-term liabilities.
A liability is a duty or responsibility for the company when they adopt for the future investment or for buying any resource for the company’s growth as a benefit. Without liabilities, companies can’t think about starting a business because no one has enough money to meet all the benefits. All the businesses have liabilities and they all need to be liable themselves to pay on time without waiting for penalty charges in case of long-term liabilities.
Where does the liability record?
The liability needs to be recorded with an exact amount so that the company can’t be confused at the time of paying off its debts. Recordation is the clear picture of liabilities of the company that is the reminder of the company with proper accounting books. Assets and liabilities are the basic part of accounting and without whom, accounting and finance are incomplete. The liability is recorded under the balance sheet on the right side by the name of current liabilities and non-current liabilities which are defined as long-term and short-term liabilities.
The expense is recorded in an income statement that shows the short-term liability such as wages, rent, electricity, salary, interest payable, advertising cost, and other expenses. By the way, liability is recorded in other accounting books such as journal books which are transferred into other financial accounting books such as Income statements and Balance Sheets.
But the purpose is the same to show the debts of the company by which owners can decide how we can pay all debts without selling any inventories and investors can decide whether we should invest in the company or not and the financial advisor tells how the company should clear their debts as soon as possible with techniques.
How do Owners and financial investors calculate liabilities?
Companies and financial investors can easily calculate the liabilities of the company by analyzing all the accounting and financial books where all liabilities are recorded as an expense and account payables. They can easily estimate all the liabilities with the help of accounting ratios and financial ratios. The formula to calculate liabilities is debt to equity ratio and debt to assets ratio, by using these two formulas analysts can find out the liabilities that companies have to pay before the financial year closes.
Now in the advanced world, analysts use software for analyzing the liabilities and calculate them so that they can avoid useless mistakes in calculations and inaccuracy in liabilities records. Through accounting software, owners can easily track all the liabilities on every update for non-mishappening in the records. Through software, owners are familiar with all the debts that they have to pay in a fixed period.
Analysts can also be a bank who checks the financials debt data before offering the funds and auditors can also be the analysts who come for the audit in the company for verifying all the accounts and check that the inventories have been sold or not and its transaction has been recorded or not. On the other hand, they check if debts have been paid off or not, if not so why they would ask the reason.
What are the types of liabilities?
As we know that liabilities are recorded under current liabilities and non-current liabilities both contain legal obligations or debt owed to individuals, companies, and other investors. Based on present transactions, the owner decides to build an entity for future events. It is a framework that has been designed by International Financial Reporting Standards (IFRS).
Liability is a present obligation that is needed to complete in the same year that no debts are left to pay for the next financial year. It may have a bad impact on the company’s goodwill and fewer chances of getting loans from any financial institutions and other investors in the future.
Current liabilities contain short-term liabilities that are due which are needed to pay within a year or we can say that it is a liability that is used for a short time. These liabilities are paid easily by the management to meet all obligations. Current liabilities such as Accounts payable, interest payable, accrued expenses, BP, Bank overdrafts, taxes. Current liabilities are used to measure the current ratio ie. current ratio, Quick ratio, Cash ratio.
Non-Current liabilities contain long-term liabilities that don’t due which are needed to pay after a long time (for 15 to 20 yrs), which is used for a long time. These liabilities are not paid easily within a purchasing year, that’s why it is considered as long-term financing which is paid after a long time. Non-Current liabilities such as Accounts payables, Deferred tax, Mortgage loans. These liabilities are carried for a big investment project that runs for a long time and gives good revenue.
These liabilities are recorded for investors to measure financial health by performing a financial analysis of a company. It is required for every investor and other analysts who are offering funds to the company so that they can become familiar with the company’s capability of paying debts.
Mortgages are the best example of long-term liabilities which are taken as a loan for a house for a long time against any collateral security.