Loading the player...

What is a 'Liability'

A liability is defined as a company's legal financial debts or obligations that arise during the course of business operations. Liabilities are settled over time through the transfer of economic benefits including money, goods or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues and accrued expenses.

BREAKING DOWN 'Liability'

Liabilities are a vital aspect of a company because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not demand payment when it delivers the goods. Rather, it invoices the restaurant for the purchase to streamline the dropoff and make paying easier for the restaurant. The outstanding money that the restaurant owes to its wine supplier is considered a liability. In contrast, the wine supplier considers the money it is owed to be an asset.

Other Definitions of Liability

Generally, liability refers to the state of being responsible for something, and this term can refer to any money or service owed to another party. Tax liability, for example, can refer to the property taxes that a homeowner owes to the municipal government or the income tax he owes to the federal government. Liability may also refer to the legal liability of a business or individual. For example, many businesses take out liability insurance in case a customer or employee sues them for negligence.

Current Versus Long-Term Liabilities

Businesses sort their liabilities into two categories: current and long-term. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period. For example, if a business takes out a mortgage payable over a 15-year period, that is a long-term liability. However, the mortgage payments that are due during the current year are considered the current portion of long-term debt and are recorded in the short-term liabilities section of the balance sheet.

Ideally, analysts want to see that a company can pay current liabilities, which are due within a year, with cash. Some examples of short-term liabilities include payroll expenses and accounts payable, which includes money owed to vendors, monthly utilities, and similar expenses. In contrast, analysts want to see that long-term liabilities can be paid with assets derived from future earnings or financing transactions. Debt is not the only long-term liability companies incur. Items like rent, deferred taxes, payroll, and pension obligations can also be listed under long-term liabilities.

The Relationship Between Liabilities and Assets

Assets are the things a company owns, and they include tangible items such as buildings, machinery, and equipment as well as intangible items such as accounts receivable, patents or intellectual property. If a business subtracts its liabilities from its assets, the difference is its owner's or stockholders' equity. This relationship can be expressed as assets - liabilities = owner's equity. However, in most cases, this equation is commonly presented as liabilities + equity = assets.

What is the Difference Between an Expense and a Liability?

An expense is the cost of operations that a company incurs to generate revenue. Unlike assets and liabilities, expenses are related to revenue, and both are listed on a company's income statement. In short, expenses are used to calculate net income. The equation to calculate net income is revenues minus expenses. For example, if a company has more expenses than revenues for the past three years, it may signal weak financial stability because it has been losing money for those years.

Expenses and liabilities should not be confused with each other. One is listed on a company's balance sheet, and the other is listed on the company's income statement. Expenses are the costs of a company's operation, while liabilities are the obligations and debts a company owes.

RELATED TERMS
  1. Long-Term Liabilities

    In accounting, long-term liabilities are financial obligations ...
  2. Total Liabilities

    Total liabilities are the aggregate of all debts an individual ...
  3. Other Long-Term Liabilities

    Other long-term liabilities are a balance sheet item that lumps ...
  4. Current Liabilities

    Current liabilities are a company's debts or obligations that ...
  5. Limited Liability

    Limited liability is a type of liability that does not exceed ...
  6. Liability Management

    Liability management is the use of customer deposits and borrowed ...
Related Articles
  1. Investing

    Examples Of Asset/Liability Management

    In its simplest form, asset/liability management entails managing assets and cash inflows to satisfy various obligations; however, it's rarely that simple.
  2. Investing

    How to Analyze a Company's Financial Position

    Find out how to calculate important ratios and compare them to market value.
  3. Small Business

    What is Unlimited Liability?

    Unlimited liability means that the owners of a business are liable for the entire amount of debt and obligations of that business.
  4. Taxes

    Deferred Tax Liability

    Deferred tax liability is a tax that has been assessed or is due for the current period, but has not yet been paid. The deferral arises because of timing differences between the accrual of the ...
  5. Investing

    Breaking Down The Balance Sheet

    Knowing what the company's financial statements mean will help you to analyze your investments.
  6. Investing

    What is Net Worth?

    Net worth is the amount by which assets exceed liabilities. Another way to say this is, it's the value of everything you own, minus all your debts.
  7. Insurance

    An Advisor's Guide to Prof. Liability Insurance

    A guide to what financial advisors need to know about professional liability insurance.
RELATED FAQS
  1. On which financial statements does a company report its long-term debt?

    A company lists its long-term debt on its balance sheet under liabilities, usually under a subheading for long-term liabilities. Read Answer >>
  2. Are accounts payable an expense?

    Learn about how to differentiate between liability accounts and expense accounts, and see why accounts payable is considered ... Read Answer >>
  3. Do tax liabilities appear in the financial statements?

    Taxes appear in some form in all three of the major financial statements: the balance sheet, the income statement and the ... Read Answer >>
  4. How do accounts payable show on the balance sheet?

    Accounts payable are listed on a company's balance sheet and are considered a short-term debt obligation owed by a company ... Read Answer >>
  5. How do you calculate net debt using Excel?

    To calculate net debt using Microsoft Excel, examine the balance sheet to find: total short-term liabilities, total long-term ... Read Answer >>
  6. What items on the balance sheet are most important in fundamental analysis?

    Read about which balance sheet items are considered most important for fundamental analysis, including cash, current liabilities ... Read Answer >>
Trading Center