Liabilities. Liabilities are bad. Well, not bad like cocaine bad (don’t do drugs kids!), but more bad in the sense that having 10 Jelly donuts in one sitting is bad for you (I’ve never tried it before myself, but I can imagine it’d be pretty bad). A liability is basically anything that you owe to other people. A liability is essentially a promise to pay a specific amount to someone at an agreed upon date in the future. In other words, Liabilities reduce your overall wealth and is in a way the direct opposite of an asset (which generates wealth for you). Often some liabilities come with nasty little things like ‘interest rates,’ which further increase the value of the liability (and the amount of cash you need to cough up).
Examples of Liabilities can include:
- Loans taken from friends, family, the bank and your friendly neighbourhood loan shark
- Credit card balances with the bank
- Bank overdrafts (which is when you borrow money from the bank through your current account)
- Amounts you owe to your suppliers for things you have bought but haven’t paid for
- Tax amounts you owe to the local tax authorities
Notice that the one thing that liabilities have in common is that they all relate to money owed to others. Often this liability is created when money is borrowed to purchase… well, you guessed it – ASSETS, in the hopes that the asset purchased today can be used to generate enough wealth to pay for liabilities owed tomorrow (in theory anyway). When businesses and individuals fail to pay off their liabilities, they can file for bankruptcy, which is legalese for “leave me alone, I’m broke!” (unless you have a loan with a loan shark, in which case, your arms are now broke(n)). Now bear in mind that being bankrupt isn’t a good thing and shouldn’t ever be considered as an option to get out of debt – its almost always a last resort.
Different governments have different rules regarding bankruptcy so its good to check with your favourite local lawyer what the laws are in your country and not rely on the word of a cute little accounting/finance blog for legal advice.
So liabilities are basically one way to get the money to buy assets, but in return you have to pay off the liability in the future, and often in the long run, you will be paying more than the value of the asset you purchased using the liability (gosh darn interest rates!!!).
Think you know everything about Assets, Equity and Liabilities? Go on here then!