The liabilities of the enterprise are the obligation it has as of the date that arose as a result of its operating, financing, and other activities, which will ultimately lead to the expenditure of assets to meet these obligations. The following signs are characteristic of the company’s obligations:
- The company can fulfill its obligations by providing services, money, or another type of assets, like goods it produces.
- The reason the company has a debt has already happened.
- The occurrence of the liability is likely.
Long-term liabilities mean obligations before other individuals and entities that a business has at least a year to fulfill. These can be, for instance, estimated liabilities, loans, deferred tax payments, various kinds of debts.
It also happens that organizations often attract financing with a long repayment period, but a portion of that loan should be typically repaid within a shorter time frame. Therefore, when financial experts consider the business’s existing long-term liabilities in order to assess the financial condition, such debts are divided into two categories: the portion due to be removed from the liabilities within the next year and the proportion that will need to be repaid in more than one year from the reporting date. The long-term liabilities that should be settled within one cycle of the company’s operations or within a year fall under short-term liabilities. These would be your monthly payments to repay the loan.
Long vs short-term liabilities
To help you better grasp the concepts, let’s contrast the example of long-term obligations with current liabilities. The first consist of several types:
- borrowed capital, which includes the total loan sum, interest, and certain additional costs associated with lending;
- deferred tax liabilities, since there is usually no expectation for them to be paid within a year;
- some estimated liabilities that are planned to be fulfilled in more than one year;
- other obligations falling under this category.
Short-term debts, in turn, also consist of different types of obligations:
- borrowed capital, which includes loans and credits for a relatively short time, as well as interest and additional costs associated with loans;
- payables, reflecting the total amount that the company must pay to the servicing bank within twelve months;
- unearned revenue, that is, the profit that was received during the reporting period, but not yet earned;
- capital expenditures, operating expenses, and lease payments;
- estimated liabilities, which reflect the amounts that are planned to be paid not more than within one year;
- other liabilities falling under this category, for example, financing received for a specific purpose and the various taxes to be paid this year.
Analysis of long-term liabilities
When looking at the financial documents of a business, you cannot say for sure that a company is doing well or not without deep analysis. Nonetheless, it can tell us a lot and serve as a basis for decision-making. The changes or lack of these changes in the long-term liabilities over a specific period of time can tell us several things. Let’s review several possible scenarios.
It might seem good when the company’s equity grows while long-term liabilities decrease and short-term debts stay the same. If the production stays the same and the equity grows thanks to the retained earnings, we can say that the company is doing good. The decision to use its own capital instead of the borrowed should be further reviewed. However, if the equity growth is done via an increase in its additional capital due to the revaluation of non-current assets, then the reduction in the long-term liabilities may be caused not by the business’s decision not to use outside resources, but rejection of creditors to provide loans.
If the long-term debt is growing, while the short-term is decreasing, and equity is on the same level, there are several possible causes. One of the obvious ones is the purchase of expensive assets with borrowed funds. At the same time, the growth of long-term liabilities is evidence of the trustworthiness of the company. This is a positive characteristic. An exception might be where the owners are also creditors, so the picture the financial document is presenting can be distorted.
There are many other reasons why the long-term liabilities go up or down. Significant variations require one to closely look at every item of the financial reports to see what provoked the increases or decreases. As you saw, it cannot be said that a decrease (or increase) is a good or bad thing without deep analysis.