What are Total Liabilities?
Total liabilities are the combined debts and obligations that an individual or company owes to outside parties. Everything the company owns is classified as an asset and all amounts the company owes for future obligations are recorded as liabilities. On the balance sheet, total assets minus total liabilities equals equity.
- Total liabilities are the combined debts that an individual or company owes.
- They are generally broken down into three categories: short-term, long-term, and other liabilities.
- On the balance sheet, total liabilities plus equity must equal total assets.
Understanding Total Liabilities
Liabilities can be described as an obligation between one party and another that has not yet been completed or paid for. They are settled over time through the transfer of economic benefits, including money, goods, or services.
Liabilities consist of many items ranging from monthly lease payments, to utility bills, bonds issued to investors and corporate credit card debt. Money received by an individual or company for a service or product that has yet to be provided or delivered, otherwise known as unearned revenue, is also recorded as a liability because the revenue has still not been earned and represents products or services owed to a customer.
Future pay-outs on things such as pending lawsuits and product warranties must be listed as liabilities, too, if the contingency is likely and the amount can be reasonably estimated. These are referred to as contingent liabilities.
Types of Liabilities
On the balance sheet, a company's total liabilities are generally split up into three categories: short-term, long-term, and other liabilities. Total liabilities are calculated by summing all short-term and long-term liabilities, along with any off-balance sheet liabilities that corporations may incur.
Short-term, or current liabilities, are liabilities that are due within one year or less. They can include payroll expenses, rent, and accounts payable (AP), money owed by a company to its customers.
Because payment is due within a year, investors and analysts are keen to ascertain that a company has enough cash on its books to cover its short-term liabilities.
Long-term liabilities, or noncurrent liabilities, are debts and other non-debt financial obligations with a maturity beyond one year. They can include debentures, loans, deferred tax liabilities, and pension obligations.
Less liquidity is required to pay for long-term liabilities as these obligations are due over a longer timeframe. Investors and analysts generally expect them to be settled with assets derived from future earnings or financing transactions. One year is generally enough time to turn inventory into cash.
When something in financial statements is referred to as “other” it typically means that it is unusual, does not fit into major categories and is considered to be relatively minor. In the case of liabilities, the “other” tag can refer to things like intercompany borrowings and sales taxes.
Investors can discover what a company’s other liabilities are by checking out the footnotes in its financial statements.
Advantages of Total Liabilities
In isolation, total liabilities serve little purpose, other than to potentially compare how a company’s obligations stack up against a competitor operating in the same sector.
However, when used with other figures, total liabilities can be a useful metric for analyzing a company's operations. One example is in an entity's debt-to-equity ratio. Used to evaluate a company's financial leverage, this ratio reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn. A similar ratio called debt-to-assets compares total liabilities to total assets to show how assets are financed.
A larger amount of total liabilities is not in-and-of-itself a financial indicator of poor economic quality of an entity. Based on prevailing interest rates available to the company, it may be most favorable for the business to acquire debt assets by incurring liabilities.
However, the total liabilities of a business have a direct relationship with the creditworthiness of an entity. In general, if a company has relatively low total liabilities, it may gain favorable interest rates on any new debt it undertakes from lenders, as lower total liabilities lessen the chance of default risk.