Liabilities are the obligations that a person, business or government owes to others and expects to settle in the future, usually by paying cash but sometimes by delivering goods, performing services or handing over other assets. A bank loan, unpaid supplier invoices, wages due to staff, taxes owed, issued bonds and money received in advance for work not yet done are all liabilities.
Liabilities form one side of the balance sheet, alongside equity, and together they show how a business's assets were financed. The IASB's 2018 Conceptual Framework describes a liability as a present obligation of the entity to transfer an economic resource as a result of past events. The word is closely related to debt, but it is wider: every debt is a liability, while some liabilities, such as provisions for warranty claims or deferred revenue, are not borrowings in the everyday sense.
Liabilities in plain terms
A liability is a promise that has already been made and still has to be kept. If a friend lends someone money, the borrower has a liability until it is repaid. If a gym member pays a year's fees in January, the gym owes eleven more months of access, which is also a liability, even though nobody borrowed anything.
The idea is like a list of IOUs pinned to a fridge. Some are due next week, some in ten years, and a few depend on whether something happens, such as a customer returning a faulty product. Adding up the list shows how much of what a household or business holds really belongs to others.
Main types of liabilities
Financial statements usually split liabilities by when they fall due:
- Current liabilities. Obligations due within a year, such as trade payables, short-term borrowings, accrued wages, taxes payable and the part of long-term debt repayable in the next twelve months.
- Non-current liabilities. Obligations due later, such as long-term bank loans, corporate bonds, pension obligations and most lease liabilities.
- Contract liabilities. Payments received before goods or services are delivered, explained in more detail under deferred revenue.
- Provisions and contingent liabilities. A provision is a liability of uncertain timing or amount that is recognized because an outflow is probable, such as a legal settlement. A contingent liability is only disclosed in the notes because the outflow is possible but not probable or cannot be measured reliably.
Since 2019, IFRS 16 and the US standard ASC 842 have required most leases to appear as liabilities, matched by a right-of-use asset. Before that, many airline and retail leases were kept off the balance sheet, which made companies look less indebted than they were.
Who stands behind a liability
Every liability has a counterparty: the creditor to whom it is owed. For the borrower, the liability is an obligation; for the lender it is an asset. When an obligation is secured on collateral, the creditor can take that collateral if payment stops. If a business cannot meet its liabilities as they fall due, it may be insolvent, and the order in which claims are paid is set by insolvency law and by debt seniority.
Limited liability matters here. The liabilities of a company belong to the company, not to its shareholders, so investors can lose what they put in but are not normally liable for the company's unpaid debts. Sole traders and general partners do not have that shield.
Liabilities in banks, central banks and governments
For a commercial bank, the largest liabilities are customer deposits. A depositor's balance is an asset to the customer and a liability of the bank, which is why sudden withdrawals can trigger a bank run and why deposit insurance exists. Banknotes and the reserves that commercial banks hold are liabilities of the issuing central bank; this is the basis of central bank money, and of proposals such as the regulated liability network that treat different forms of money as liabilities of different institutions.
Governments carry liabilities too. Outstanding government bonds and bills make up the national debt, and many statisticians also track unfunded pension promises and guarantees. A sovereign guarantee on a state company's loan is a contingent liability that becomes real only if the company fails.
Measuring and judging liabilities
Most financial liabilities are carried at amortized cost, although some, such as derivatives, are measured at fair value. Analysts compare liabilities with assets and earnings to judge risk. Common measures include the debt-to-equity or gearing ratio, the current ratio (current assets divided by current liabilities) and interest cover. Heavy reliance on borrowed money raises leverage, which magnifies returns in good times and losses in bad ones.
A simple example: a shop with $200,000 of assets, $50,000 of current liabilities and $70,000 of long-term loans has total liabilities of $120,000, leaving equity, or book value, of $80,000. If the shop's current assets are $75,000, its current ratio is 1.5, meaning it holds $1.50 of short-term resources for every dollar due within the year.