Total Liabilities: Definition & Calculation
Any business owner will know the importance of keeping a track of their liabilities. But there are a number of different types of liabilities that are needed to be taken into account.
If you’re an accountant or a business owner, you need to know exactly what total liabilities are and the different ways in which they can affect your balance sheet.
Read on as we take a look at what exactly total liabilities are. We’ll take you through the correct definition, the formula and calculation, the advantages and disadvantages, and why liabilities are so important to businesses.
Table of Contents
- Total liabilities are any debts and obligations that a company or individual owes to another party.
- Total liabilities can be an important financial metric for company operations.
- Total liabilities are usually split into three distinct categories. These are short-term liabilities, long-term liabilities, and other liabilities.
What Are Total Liabilities?
Businesses of any kind are going to have certain debts and obligations they need to pay to another party. Total liabilities are the combination of those debts and obligations. Things that a business owns are considered and classified as assets and contribute to financial health, financial position, and other economic benefits.
On the flip side, any amount that the business owes regarding future financial obligations is recorded as liabilities. When you take a look at a company’s balance sheet, subtracting total liabilities from total assets will determine equity.
Total Liabilities Formula and Calculation
Total liabilities can be fairly simple to calculate. You need to simply add any long-term and short-term liabilities together. As well, any off-balance sheet liabilities that a business has should also get added to this calculation.
The formula for calculating total liabilities would look like this:
The total sum ends up being the total liabilities of the company. For example, let’s say that company A has $10,000 in short-term liabilities and $25,000 of long-term liability, or noncurrent liabilities.
$10,000 + $25,000 = $35,000 in total liabilities for the company
Types of Liabilities
As mentioned above, liabilities can get split into short-term, long-term, and other liabilities, which are found on income statements and balance sheets. Here are some of the most common types that you could find in the broad categories.
These are commonly referred to as current liabilities and they are always due within one year. Some of the most common include rent, accounts payable, and payroll expenses.
Long-term liabilities are also known as non-current liabilities and they are any debts or non-debt financial obligations that are due in more than one year. Typically, some of the most common can include pension obligations, deferred tax liabilities, loans, and debentures.
If you ever look at a financial statement and see something listed as other, it means that it doesn’t fit into any of the other major categories. And it’s usually considered to be minor or unusual.
For example, a company might have sales taxes and intracompany borrowings listed as other on the balance sheet. If an investor is looking into a company’s other liabilities, they will often be listed in the financial statements‘ footnotes.
Advantages of Total Liabilities
On their own, total liabilities only really show how the obligations of a business compare to another. Yet, when looking at total liabilities with additional figures, they can be a very useful financial metric to see how well a company is operating.
The debt-to-equity ratio is an effective ratio used to evaluate the financial leverage a company has. It breaks down and looks into the ability of shareholder equity to cover any outstanding debts. As well, the debt-to-assets ratio helps compare total assets to total liabilities. This helps you gain insights into how certain assets get financed.
Disadvantages of Total Liabilities
The advantages and disadvantages might vary depending on the business and industry. However, there are still a few disadvantages that come with total liabilities no matter your type of business. These include:
- Reduced value in ownership
- Increased risk of default or being unable to repay
- Difficulty obtaining additional financing
- Potentially violating debt covenants
Why Are Liabilities Important to Business?
It can be incredibly difficult for a business to continue steady operations and see growth without taking on liabilities. Having an effective balance of equity and liabilities will play an integral role in establishing a company’s foundation.
When a company takes on too much debt, it makes it a challenge to make payments on time. Ultimately, this can negatively affect sales. In essence, liabilities are important to help a business grow, yet there is a need to balance liabilities and equity to stay profitable.
Liabilities – Special Considerations
Having a high level of total liabilities doesn’t always indicate a company is performing poorly. Depending on the interest rates available, acquiring debt assets by incurring liabilities might be the best option for the business.
That said, it’s worth mentioning that total liabilities are directly related to your creditworthiness. This means that if you have low total liabilities you might find more favorable interest rates. You can reduce your chance of default risk by having lower total liabilities.
Total liabilities are any debts or obligations that a company has to another party. Liabilities are broken into short-term, long-term debt liabilities, and others. And they include things like accounts payable, pension obligations, income tax liabilities, contingent liabilities, and sales taxes.
Total liabilities don’t tell much of a story on their own, but they can provide valuable insights when combined with other financial metrics and ratios. These can include ratios like debt-to-equity, which uses calculations from the income statement and balance sheet.
Plus, balancing short-term and long-term liabilities can help with the amounts of cash and cash reserves a business has access to. This can all help contribute to a healthy business and balance future obligations.
FAQs About Total Liabilities
Are Total Liabilities the Same as Total Debt?
The primary difference between a liability and debt is that liabilities are the total amount of financial obligations, not just a single one. In essence, debt is a type of subset of liabilities in general.
Do Total Liabilities Include Non-Current Liabilities?
Simply put, yes, total liabilities include non-current liabilities. This is since total liabilities are defined as the total amounts that are due to suppliers or creditors.
Are Liabilities Good?
It depends on the specific type of liability and its purpose. For example, taking out a loan to purchase new assets to grow your business is a good liability. However, having too much liability can hurt business financials if they’re not managed properly.
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