In Accounting, are liabilities a good thing or a bad thing?

Think of it like adding a negative number.
The whole picture shows a companies health. If you only give the assets without showing the liabilities you will not have any idea of the companies true value. You need all the information.

@Judi But if liabilities are added as a negative, wouldn’t that make “Assets = Equity – Liabilities”? The formula makes it sound as if liabilities are a positive thing. It’s quite confusing..

It’s not considered a “good thing”. Think of it as this :

Assets – Liabilities = Equity . In other words, your net of assets minus what you owe shows how much your company is worth. If you owe more than you have in assets, your ownership is of negative worth.

@zenvelo Oh I must have been mistaken til now. A company’s value is shown as equity right? Assets are a different thing. So if I wanted to find out a company’s value I would have to look for Equity.

You would come at the same conclusion.
I am no math wizard but I have been in business for a long time.
Assets=(liabilities)+equity. The ( ) means you subtract in accounting. They are trying to get you to think like a spreadsheet.

To find the value of the company you would determine the value of the assets minus the liabilities but there are a bunch of other factors to consider too. They are not as easy for accountants to quantify. Growth potential, market conditions, regional trends…..

@frigate1985 Yes, a company’s assets includes capital goods, cash on hand, accounts receivable, and any other notes, etc.

I heard of the “unaccountable” factors like customer loyalty, brand value, etc.
It seems nothing is easy in life….
So much new things to learn and be confused by

Wait until you start on Goodwill. Pay 1 million for a company with 100,000 in assets. The 900,000 balance gets booked by the buying company as “goodwill” and considered an asset, but it is intangible.

You seem like the type of person who will like the certainty aspect of accounting. Unless you are an appraiser you won’t have to worry to much about those unaccountable factors. Real Estate for example ( income properties) can be valued pretty accurately by determining income, expenses, assets and liabilities and deferred maintenance. There is usually a capitalization rate that is used and changes with market conditions and region, but many investors buy sight unseen based on this information alone. It’s just a formula.

Liabilities are neither good nor bad per se. See here.

What you are describing is the basic accounting equation: Assets = Liabilities + Equity. A company always wants this equation to be in balance.

Liabilities represent amounts owed others – one way to look at that as a “good thing” is to consider a company’s capital structure – for example a bank loan/line of credit is a debt (liability), but in exchange for that debt you recieve an asset (cash) to help finance the business. So, if you have a loan for $100K you have a liability in the form of a loan, but also an asset in the form of cash.

http://www.accountingcoach.com/online-accounting-course/14Xpg01.html

Some liabilities hold tax advantages. Liabilities are things like loans or leases, where you are paying something off and in some instances, are better than owning an expensive, depreciating asset in-full. Other liabilities can be bad, like owing your staff vacation time. Too much accrued vacation time on the books can look really bad and that is why many businesses tell employees ‘take it or lose it’.

Leases, loans, employee benefits….. (it has been so long, I can hardly remember any of this stuff….) They can be good tax-wise in some countries….

@BosM that cash asset is usually gone quicker than you can wink and it is no longer an asset. You end up using that money for wages, expenses, rent…. you got nothing but debt.

Liabilities are something that are generally owed over time, and are generally tied, but not always, to something of intrinsic value, like a secured loan of some type or a lease on a fleet of vehicles, but they are also unavoidable and legislated payables, like taxes and employee benefits that are state mandated. Liabilities are a favorite toy of people selling franchises (watch your backs people…) Expenses are running costs, like electricity, office supplies, raw materials..etc.

We used to tell our clients that when they were taking on simple bank loans or oddly structured capital funding, to always consider what the worst case scenario they could live with. ‘If the venture fails, can you still service the loan without losing your house by going back to your teaching job.’ for example. I hated the oddly structured capital funding and saw far too much bulls hit from financial cowboys in Auckland.

So, I would echo what @bob_ says… they are neither good nor bad, but they can be used for evil if you don’t know what you are signing.

@Cazzie – she asked how a liability could be considered a good thing, I gave her an example. Sure, if you use a loan to fund operations (not a good thing BTW) you are correct, however you have a business that is not generating enough revenue (cash) to fund operating costs, which is not good, unless it is a line of credit used to fund short term cash needs.

If you use a loan to fund an asset purchase such as equipment, buildings, etc. then that is typically what a “loan” is used for and in return you have a depreciable asset.

It is a bookkeeping mechanism. Double entry bookkeeping arose as part of the Italian Renaissance. It is a clever way of keeping tabs on income and spending and catching errors.

@BosM in your scenario, the liability is not a good thing. You said ‘cash’... which I took to mean ‘cash flow’. If you meant for the purchase of capital item, that is another thing entirely.

Assets are the things one ‘owns’ like offices, outstanding invoices. cars, pencils, etc.
These are found on one side of the balance sheet.
edit: if you are a pencil factory, else you would consider pencils as expenses. :) @cazzle

On the other side of the balance sheet, it shows how those assets are financed.
Equity: the company’s own accumulated wealth. (It can be negative, even if only losses have been made.)
Liabilities: money that the company has borrowed to finance the assets.

Liabilities are a funding source for the company and as such they are good. they allow a company with limited own wealth to make more money than it could make without those liabilities.

In real life, liabilities are often provided by external parties that want interest or some other costs of capital). As long as the assets funded make more return than those costs of capital, the liabilities contribute to the return on equity.

Another positive effect of liabilities is that it offers another management component. Foreign capital will require more deliberate management pratices and strategies. Companies that have foreign capital are therefore forced to behave more professional.

@whitenoise I don’t know about the ‘Foreign capital will encourage more professional behaviour’.... I have seen too much…. *shakes head

(also, one does not capitalise ‘pencils’. they are an expense, not a capital item… *giggle.. just kidding, I know you wrote that as an example quickly….)

@cazzie

Well… it should, but you’re right. Personal targets of bankers handing out money like there is no tomorrow and then moving to their next job…

@cazzie If you are selling pencils, or making them… :-)

@whitenoise hahahaha!! I love this accounting humour. It has been too long. *finished stock on hand. sigh….. I need to go back to school and get that damn qualification på norsk.

@BosM
re “What you are describing is the basic accounting equation: Assets = Liabilities + Equity. A company always wants this equation to be in balance.”

These are in balance by definition, at least the way I understand accounting.

@frigate1985 You may want to look up the definition of ‘balance sheet insolvency’ is. Liabilities are bad when they exceed net assets. This doesn’t mean that a business is bankrupt. It is different from being cash-flow insolvent, which means not having the cash to pay your debts.

One of the largest liabilities that can accrue dangerously on the balance sheet is ‘accounts payable’. These are the unsecured creditors, like your gas or power bill and other expenses where you buy supplies, and your suppliers send you an invoice that is due on the 20th of the following month. These guys can be somewhat flexible, but it is not a good idea to piss them off.

You can have more liability than assets (definition of balance-sheet insolvent, and, indeed, some very large corporations run like this as a matter of course), and still not have any court problems because your cashflow is healthy enough to pay all the payables and liabilites.

I was involved in proceedings against a company that was petitioning all its creditors to allow them to continue trading. They were balance sheet insolvent and cash-flow poor. They had a proposal put together by an Investment Banking firm and paid a huge sum to them and called up all up for a meeting to plea for a stay of execution. We voted to not allow them to continue trading. The ensuing court case ruled, demanding the investment banking firm return the fee the company paid, writing in her judgement, ‘This court has found that the investment banking firm of blank, blank and blank and the defaulting company defendant /Assrat & Co*, were not working in good faith and undertook the work knowing full well that the defaulting company, their client, was in an insolvent position and unable to service any further debt.’ so.. HA! but I never saw my money and took a hit for about $20,000.
*not really the name of the company.

@cazzie
You make it very tempting to go into all kinds of further details and discussions.

That would however make things very complicated. I used to be a banker and I have run my own company. I have been evaluating balance sheets from both sides of the table.

Whether balance sheet insolvency should bankrupt a company is entirely dependent on the debt structure, cash flow expectations and asset composition / valuation.

A balance sheet insolvency with a company that has subordinated debt on its balance sheet, that was just bought, has written of goodwill, shouldn’t be an issue if there is a positive cash flow expectation.

A cash rich company with positive equity, a whimsical shareholder and no fixed assets that can easily be sold may be far trickier.

I only now realize that it can actually be fun talking about this stuff.

if you understand the following puzzle, then you may understand the basic of accounting as well:

On a cattle market:
A man buys a horse for 50 dollars, then an hour later decides he wants to sell it again and gets 60 dollars for it. However… he gets doubts about this beautiful animal and decides to buy it back again for 70 dollars.

However, his trailer brakes down, he can no longer keep the animal and he sells it after all, for 80 dollars.

Did he make money? lose money? How much… or did he break even? Explain why.

@whitenoise Should I have a go? I will send it PM.
You think this stuff is fun to talk about only now after having spending how many years in the industry? I used to live and breathe small business accounting and management. I loved it so much, I married an associate partner of the accounting firm and we opened our own practice. (I don’t recommend doing that.)

I totally agree about balance sheet insolvency, but it is a line of management and a structure that some corporations operate under intentionally.

A company that has stable and appreciating assets, like apartment buildings, for example, won’t want to lie exposed to the asset taxes here in Norway. Rather, they want to borrow against their buildings, use the cash and pay the low interest rates on the cash and use that to offset their rising property valuations. This encourages landlords here to make building improvements often and supply and upgrade whiteware for tenants that can be written off against their taxable income. Not a great example of being a balance sheet insolvent business, but perhaps a good example of increasing liabilities and lowering tax exposure for the benefit of the shareholders, customers and business (and banks). ;)

@cazzie Accounting really must be your perfect field of profession. I haven’t found mine yet… Still taking introduction to business administration haha

Thanks, @frigate1985. That is encouraging. I am currently re-assessing my life, with the break up of a marriage in an adopted country. I will need to go to school for at least 2 years or so to get qualified here to do the job I was doing over 10 years ago in New Zealand.