How to Read Financial Reports for Liabilities - dummies

How to Read Financial Reports for Liabilities

By Lita Epstein

Companies must spend money to conduct their day-to-day operations, which must be accounted for on financial reports. Whenever a company makes a commitment to spend money on credit, be it short-term credit using a credit card or long-term credit using a mortgage, that commitment becomes a debt or liability.

Current liabilities

Current liabilities are any obligations that a company must pay during the next 12 months. These include short-term borrowings, the current portion of long-term debt, accounts payable, and accrued liabilities. If a company can’t pay these bills, it may go into bankruptcy or out of business.

Short-term borrowings

Short-term borrowings are usually lines of credit a company takes to manage cash flow. A company borrowing this way isn’t much different from you using a credit card or personal loan to pay bills until your next paycheck. These types of loans usually carry the highest interest-rate charges, so if a firm can’t repay them quickly, it converts the debt to something longer term with lower interest rates.

This type of liability should be a relatively low number on the balance sheet, compared with other liabilities. A number that isn’t low may be a sign of trouble, indicating that the company is having difficulty securing long-term debt or meeting its cash obligations.

Current portion of long-term debt

This line item of the balance sheet shows payments due on long-term debt during the current fiscal year. The long-term liabilities section reflects any portion of the debt that a company owes beyond the current 12 months.

Accounts payable

Companies list money they owe to others for products, services, supplies, and other short-term needs (invoices due in less than 12 months) in accounts payable. They record payments due to vendors, suppliers, contractors, and other companies they do business with.

Accrued liabilities

Liabilities that a company has accrued but hasn’t yet paid at the time it prepares the balance sheet are totaled in accrued liabilities. For example, companies include income taxes, royalties, advertising, payroll, management incentives, and employee taxes they haven’t yet paid in this line item.

Sometimes a firm breaks out items individually, like income taxes payable, without using a catchall line item called accrued liabilities. When you look in the notes, you see more details about the types of financial obligations included and the total of each type of liability.

Long-term liabilities

Any money a business must pay out for more than 12 months in the future is considered a long-term liability. Long-term liabilities don’t throw a company into bankruptcy, but if they become too large, the company may have trouble paying its bills in the future.

Many companies keep the long-term liabilities section short and sweet, and group almost everything under one lump sum, such as long-term debt. Long-term debt includes mortgages on buildings, loans on machinery or equipment, or bonds the company needs to repay at some point in the future. Other companies break out the type of debt, showing mortgages payable, loans payable, and bonds payable.

For example, both Hasbro and Mattel take the short-and-sweet route, giving the financial report reader little detail on the balance sheet. Instead, a reader must dig through the notes and management’s discussion and analysis to find more details about the liabilities.

You can find more details about what a company actually groups in the other liability category in the notes to the financial statements.