Spontaneous Liabilities

What Are Spontaneous Liabilities?

Spontaneous liabilities are the obligations of a company that are accumulated automatically as a result of the company's day-to-day business. An increase in spontaneous liabilities is normally tied to an increase in a company's cost of goods sold (or cost of sales), which are the costs involved in production.

Fixed costs, such as the cost of a factory building, do not rise and fall with sales volumes and therefore are not spontaneous liabilities.

Understanding Spontaneous Liabilities

Spontaneous liabilities are called "spontaneous" because they arise from changes in sales activity. In other words, spontaneous liabilities are not directly controlled by the firm, but instead are controlled by sales or production volumes.

Accounts payable are short-term debt obligations owed to creditors and suppliers. For example, if a company owes its supplier for raw materials used in production, the company would typically have time to pay the invoice. The terms for payables might be 30, 60, or 90 days in the future. Wages payable for those workers tied to production if there's overtime or added shifts as sales increase.

Also, taxes payable might fall under spontaneous liabilities since the company's profit would rise with sales leading to larger tax liability to the Internal revenue Service.

In general, any rise in sales will usually lead to an increase in the cost of goods sold (COGS) if the company is a product manufacturer, or an increase in the cost of sales (COS) if the company provides services. The upturn in COGS or COS is due to increased production and labor activity to replace sold inventory or support additional service sales.

Why Spontaneous Liabilities Are Important

The projected growth in spontaneous liabilities is an important component for firms to consider as they manage corresponding accounts on the other side of the balance sheet—current assets. Current assets are short-term assets such as cash and money owed by customers in the form of accounts receivables.

Working capital (or current assets minus current liabilities) is a key part of funding the ongoing operations of a firm. If the major components of current assets such as cash, accounts receivable, and inventory, do not consistently and comfortably exceed current liabilities, then a company may eventually find itself in a challenging financial situation to meet its spontaneous liabilities.

Example of Spontaneous Liabilities

Below is a portion of the income statement for Tesla (TSLA) as reported in the company's quarterly earnings on June 30, 2019.

Our key takeaways are as follows:

• Tesla's automotive sales or revenue came in at $5.1 billion from $3.1 billion a year earlier (highlighted in green).
• The sales or revenue increase in June of 2019 was a 64% jump in revenue from 2018.
• The company's cost of sales (or cost of goods sold) from automotive sales rose from $2.5 billion to $4.2 billion in 2018 (highlighted in red).
• The rise in the cost of revenues in 2019 was a 68% jump from the same period a year earlier.

Although Tesla's sales saw a massive increase year-over-year, the cost of those sales rose even more. The quarter for Tesla highlights how the cost of goods sold is a spontaneous liability, and how it correlates closely with sales volumes.

Also, the company's overhead costs or sales, general, and administrative (SG&A) expenses (highlighted in orange) did not correlate with sales, showing that SG&A is not a spontaneous liability.

It's important to note that Tesla's results demonstrate the importance for investors to monitor the costs associated with generating sales and not merely a company's year-to-year revenue growth.