What Is a Liability?

 A liability is something that a person or company owes, usually a sum of money. Liabilities are settled
over time through the transfer of economic benefits including money, goods, or services. They're
recorded on the right side of the balance sheet and include loans, accounts payable, mortgages, deferred
revenues, bonds, warranties, and accrued expenses.
 Liabilities are the opposite of assets. They refer to things that you owe or have borrowed. Assets are
things that you own or are owed.
KEY TAKEAWAYS

 A liability is generally something that's owed to someone else.

 Liability can also mean a legal or regulatory risk or obligation.
 Companies book liabilities in opposition to assets in accounting.
 Current liabilities are a company's short-term financial obligations that are due within one year or a normal
operating cycle.
 Long-term, non-current liabilities are listed on the balance sheet as obligations but they're not due for more
than a year.

How Liabilities Work

 A liability is generally an obligation between one party and another that's not yet completed or paid. A
financial liability is also an obligation in the world of accounting but it's defined more by previous
business transactions, events, sales, exchange of assets or services, or anything that would provide
economic benefit at a later date.
 Liabilities are categorized as current or non-current depending on their temporality. They can include a
future service owed to others such as short- or long-term borrowing from banks, individuals, or other
entities or a previous transaction that's created an unsettled obligation.
FAST FACT
Current liabilities are usually considered short-term. They're expected to be concluded within 12 months or less. Non-
current liabilities are long-term. They're expected to last 12 months or longer.

 The most common liabilities are usually the largest such as accounts payable and bonds payable. Most
companies will have these two-line items on their balance sheets because they're part of ongoing current
and long-term operations.
 Liabilities are a vital aspect of a company because they're used to finance operations and pay for large
expansions. They can also make transactions between businesses more efficient. A wine supplier
typically doesn't demand payment when it sells a case of wine to a restaurant and delivers the goods. It
invoices the restaurant for the purchase to streamline the drop-off and make paying easier for the
restaurant.
 The outstanding money that the restaurant owes to its wine supplier is considered a liability. The wine
supplier considers the money it is owed to be an asset.
Other Definitions of Liability
 Liability generally refers to the state of being responsible for something. The term can refer to any
money or service owed to another party. Tax liability can refer to the property taxes that a homeowner
owes to the municipal government or the income tax they owe to the federal government. A retailer has
a sales tax liability on their books when they collect sales tax from a customer until they remit those
funds to the county, city, or state.
 Liability can also refer to one's potential damages in a civil lawsuit.

IMPORTANT:
Liability may also refer to the legal liability of a business or individual. Many businesses take out liability
insurance in case a customer or employee sues them for negligence.

Current vs. Non-Current Liabilities

It's a long-term liability if a business takes out a mortgage that's payable over a 15-year period but the mortgage
payments that are due during the current year are the current portion of long-term debt. They're recorded in the
short-term liabilities section of the balance sheet.

Current (Near-Term) Liabilities

Analysts ideally want to see that a company can pay current liabilities that are due within a year with cash.
Some examples of short-term liabilities include payroll expenses and accounts payable which can include
money owed to vendors, monthly utilities, and similar expenses. Other examples include:
 Wages payable: This is the total amount of accrued income that employees have earned but haven't yet
received. Many companies pay their employees every two weeks so this liability changes often.
 Interest payable: Companies often use credit to purchase goods and services. This represents the
interest on those short-term credit purchases that must be paid.
 Dividends payable: This represents the amount owed to shareholders after a dividend was declared for
companies that have issued stock to investors and pay dividends.
 Unearned revenues: This is a company's liability to deliver goods and/or services at a future date after
being paid in advance. The amount will be reduced in the future with an offsetting entry when the
product or service is delivered.
 Liabilities of discontinued operations: This is a unique liability. Companies are required to account for
the financial impact of an operation, division, or entity that's currently being held for sale or has been
recently sold. This also includes the financial impact of a product line that has recently been shut down.

Non-Current (Long-Term) Liabilities

Any liability that's not near-term falls under non-current liabilities that are expected to be paid in 12 months or
more. Long-term debt is also known as bonds payable and it's usually the largest liability and at the top of the
list.
Companies of all sizes finance part of their ongoing long-term operations by issuing bonds that are essentially
loans from each party that purchases the bonds. This line item is in constant flux as bonds are issued, mature, or
called back by the issuer.
Analysts want to see that long-term liabilities can be paid with assets derived from future earnings or financing
transactions. Bonds and loans aren't the only long-term liabilities that companies incur. Items like rent, deferred
taxes, payroll, and pension obligations can also be listed as long-term liabilities. Other examples include:
 Warranty liability: Some liabilities aren't as exact as AP. They have to be estimated. Warranty liability is
the estimated time and money that may be spent repairing products under the agreement of a warranty.
It's a common liability in the automotive industry because many cars have long-term warranties that can
be costly.
 Contingent liability evaluation: A contingent liability may or may not occur depending on the outcome
of an uncertain future event.
 Deferred credits: This is a broad category that can be recorded as current or non-current depending on
the specifics of the transaction. These credits are revenue collected before it's recorded as earned on the
income statement. They can include customer advances, deferred revenue, or a transaction where credits
are owed but not yet considered revenue. This item is reduced by the amount earned and becomes part
of the company's revenue stream when the revenue is no longer deferred.
 Post-employment benefits: These are benefits that an employee or family member may receive upon
their retirement. They're carried as long-term liabilities as they accrue. This liability isn't to be
overlooked with rapidly rising health care and deferred compensation.
 Unamortized investment tax credits (UITC): This represents the net between an asset's historical cost
and the amount that's already been depreciated. The unamortized portion is a liability but it's only a
rough estimate of the asset’s fair market value. This provides an analyst with some details regarding
how aggressive or conservative a company is with its depreciation methods.

Liabilities vs. Assets

Assets are what a company owns or something that's owed to the company. They include tangible items such as
buildings, machinery, and equipment as well as intangibles such as accounts receivable, interest owed, patents,
or intellectual property.
The difference is its owner's or stockholders' equity if a business subtracts its liabilities from its assets. The
relationship can be expressed like this:
𝑨𝒔𝒔𝒆𝒕𝒔 − 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 = 𝑶𝒘𝒏𝒆𝒓’𝒔 𝑬𝒒𝒖𝒊𝒕𝒚
This accounting equation is commonly presented this way, however:
𝑨𝒔𝒔𝒆𝒕𝒔 = 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 + 𝑬𝒒𝒖𝒊𝒕𝒚

Liabilities vs. Expenses

An expense is the cost of operations that a company incurs to generate revenue. Expenses are related to revenue,
unlike assets and liabilities. Both are listed on a company's income statement. Expenses are used to calculate net
income. The equation is revenues minus expenses.

FAST FACT
It might signal weak financial stability if a company has had more expenses than revenues for the last three
years because it's been losing money for those years.
Liabilities are listed on a company's balance sheet and expenses are listed on a company's income statement.
Expenses are the costs of a company's operation. Liabilities are the obligations and debts that a company owes.
Expenses can be paid immediately with cash or the payment could be delayed which would create a liability.

Example of Liabilities
Let's look at a historical example using AT&T's (T) 2020 balance sheet.
The current/short-term liabilities are separated from long-term/non-current liabilities.

AT&T clearly defines its bank debt that's maturing in less than one year under current liabilities. This is often
used as operating capital for day-to-day operations by a company of this size rather than funding larger items
which would be better suited using long-term debt.
Liabilities are carried at cost, not market value, like most assets. They can be listed in order of preference under
generally accepted accounting principle (GAAP) rules as long as they're categorized. The AT&T example has a
relatively high debt level under current liabilities. Other line items like accounts payable (AP) and various
future liabilities like payroll taxes will be higher current debt obligations for smaller companies.
AP typically carries the largest balances because they encompass day-to-day operations. AP can include
services, raw materials, office supplies, or any other categories of products and services where no promissory
note is issued. Most companies don't pay for goods and services as they're acquired, AP is equivalent to a stack
of bills waiting to be paid.

How Do I Know If Something Is a Liability?

A liability is anything that's borrowed from, owed to, or obligated to someone else. It can be real like a bill that
must be paid or potential such as a possible lawsuit. A liability isn't necessarily a bad thing. A company might
take out debt to expand and grow its business or an individual may take out a mortgage to purchase a home.

How Are Current Liabilities Different From Long-Term Non-Current Ones?

Companies segregate their liabilities by their time horizon for when they're due. Current liabilities are due
within a year and are often paid using current assets. Non-current liabilities are due in more than one year and
most often include debt repayments and deferred payments.

What Is a Contingent Liability?

A contingent liability is an obligation that might have to be paid in the future but there are still unresolved
matters that make it only a possibility, not a certainty. Lawsuits and the threat of lawsuits are the most common
contingent liabilities but unused gift cards, product warranties, and recalls also fit into this category.

What Are Examples of Liabilities That Individuals or Households Have?

An individual's or household's net worth is also arrived at by balancing assets against liabilities. Liabilities for
most households will include taxes due, bills that must be paid, rent or mortgage payments, loan interest, and
principal due. The work owed may also be construed as a liability if you're prepaid for performing work or a
service,

The Bottom Line

A liability is anything you owe to another individual or an entity such as a lender or tax authority. The term can
also refer to a legal obligation or an action you’re obligated to take.
Both businesses and individuals can have liabilities. Your loan is a liability if you borrow money to purchase a
car. The portion of the vehicle that you’ve already paid for is an asset. Financial liabilities can be either long-
term or short-term depending on whether you’ll be paying them off within a year.
Current liabilities
 Accounts payable: The amount a business owes but has not paid yet
 Short-term loans: Loans that are due within one year
 Accrued expenses: Expenses that have occurred but have not yet been invoiced
 Bank account overdrafts: Small advances made by a bank to allow a business to process transactions
 Customer deposits: Payments made by customers before receiving products or services
 Salaries payable: Amounts owed to employees
Non-current liabilities
 Long-term loans: Loans that are not due within one year
 Bonds payable: Marketable securities with a specified maturity date and interest rate
 Mortgage payable: Loans used to purchase property
 Deferred tax: Taxes owed but not due immediately
 Leases: Payments for the use of another person's property or assets
 Pensions: Retirement funds for employees
Contingent liabilities
 Potential lawsuits: A potential lawsuit is an example of a contingent liability
 Warranty obligations: A company might be liable for a product warranty
 Liabilities are recorded on the right side of a company's balance sheet.
What is Equity?
In finance and accounting, equity is the value attributable to the owners of a business. The book value of equity
is calculated as the difference between assets and liabilities on the company’s balance sheet, while the market
value of equity is based on the current share price (if public) or a value that is determined by investors or
valuation professionals. The account may also be called shareholders/owners/stockholders equity or net worth.

How Equity Works

Owners of a company (whether public or private) have shares that legally represent their ownership in the
company. Each share of the same class has the exact same rights and privileges as all other shares of the same
class. This is part of the term’s meaning – equity meaning “equal”.
Companies can issue new shares by selling them to investors in exchange for cash. Companies use the proceeds
from the share sale to fund their business, grow operations, hire more people, and make acquisitions. Once the
shares have been issued, investors can buy and sell them from each other in the secondary market (how stocks
normally trade on an exchange).

There are generally two types of equity value:

 Book value
 Market value

#1 Book Value of Equity

In accounting, equity is always listed at its book value. This is the value that accountants determine by
preparing financial statements and the balance sheet equation that states: assets = liabilities + equity. The
equation can be rearranged to: equity = assets – liabilities.
The value of a company’s assets is the sum of each current and non-current asset on the balance sheet. The main
asset accounts include cash, accounts receivable, inventory, prepaid expenses, fixed assets, property plant and
equipment (PP&E), goodwill, intellectual property, and intangible assets.
The value of liabilities is the sum of each current and non-current liability on the balance sheet. Common
liability accounts include lines of credit, accounts payable, short-term debt, deferred revenue, long-term debt,
capital leases, and any fixed financial commitment.
In reality, the value of equity is calculated in a much more detailed way and is a function of the following
accounts:
 Share capital
 Contributed surplus
 Retained earnings
 Net income (loss)
 Dividends
To fully calculate the value, accountants must track all capital the company has raised and repurchased (its
share capital), as well as its retained earnings, which consist of cumulative net income minus cumulative
dividends. The sum of share capital and retained earnings is equal to equity.

Book Value of Equity (Accounting)

Accountants are concerned with recording and reporting the financial position of a company, and, therefore,
focus on calculating the book value of equity. In order for the balance sheet to balance, the formula Equity =
Assets – Liabilities must be true.

Book Value Formula

There are various ways to calculate or calculate the book value of equity for a company. Below are several
methods that can be used to calculate the value:
 Assets – Liabilities
 Share Capital + Retained Earnings
 Share Capital + Contributed Surplus + Cumulative Net Earnings – Cumulative Dividends

#2 Market Value of Equity

 In finance, equity is typically expressed as a market value, which may be materially higher or lower than
the book value. The reason for this difference is that accounting statements are backward-looking (all
results are from the past) while financial analysts look forward, to the future, to forecast what they
believe financial performance will be.
 If a company is publicly traded, the market value of its equity is easy to calculate. It’s simply the latest
share price multiplied by the total number of shares outstanding.
 If a company is private, then it’s much harder to determine its market value. If the company needs to be
formally valued, it will often hire professionals such as investment bankers, accounting firms (valuations
group), or boutique valuation firms to perform a thorough analysis.
Estimating the Market Value of Equity
 If a company is private, the market value must be estimated. This is a very subjective process, and two
different professionals can arrive at dramatically different values for the same business.
 The most common methods used to estimate equity value are:
o Discounted cash flow (DCF) analysis
o Comparable company analysis
o Precedent transactions
In the discounted cash flow approach, an analyst will forecast all future free cash flow for a business and
discount it back to the present value using a discount rate (such as the weighted average cost of capital). DCF
valuation is a very detailed form of valuation and requires access to significant amounts of company
information. It is also the most heavily relied on approach, as it incorporates all aspects of a business and is,
therefore, considered the most accurate and complete measure.

Market Value of Equity (Finance)

Financial analysts are typically concerned with the market value of equity, which is the current price or fair
value they believe shares of the business are worth. Since finance professionals want to know how much of a
return they can make on an investment, they need to understand how much the investment will cost them, and
how much they believe they can sell it for.

Market Value Formula

There are various ways to calculate or estimate the market value of equity for a company. Below are several
methods that can be used to calculate the value:
 Market capitalization – equal to the number of shares outstanding x market price (this is only for public
companies)
 Net Present Value (NPV) of all future equity cash flows of the business
 Comparable Company Analysis
 Precedent Transactions

Personal equity (Net worth)

The concept of equity applies to individual people as much as it does to businesses. We all have our own
personal net worth, and a variety of assets and liabilities we can use to calculate our net worth.
Common examples of personal assets include:
 Cash
 Real estate
 Investments
 Furniture and household items
 Cars and other vehicles
Common examples of personal liabilities include:
 Credit card debt
 Lines of credit
 Outstanding bills (phone, electric, water, etc.)
 Student loans
 Mortgages
 The difference between all your assets and all your liabilities is your personal net worth.

Example in Excel
Let’s look at an example of two different approaches in Excel. The first is the accounting approach, which
determines the book value, and the second is the finance approach, which estimates the market value.