If you are thinking of starting a business, or if you have already started one, you have realized that there are financial concepts that are essential to understand and to handle well to guarantee the success of your idea. Because you won’t get very far if you don’t organize your company’s accounting properly, no matter how good your project is. That’s why, this time, we’re going to take a closer look at what financial liabilities are.
What Are Financial Liabilities?
Financial liabilities are the opposite of financial assets. If the latter is what constitutes the assets of your company (the premises where we carry out the activity, the machines, the shares, etc.), the liabilities are the obligations and debts that have been contracted with other people, natural or legal, and that we must pay at a specific time.
But these liabilities are not always covered by money. In many cases, we can settle the liability with tangible or intangible assets. For example, by transferring shares in our company to a third party in exchange for the money they loaned us.
What Are Active and Passive Transactions?
The difference between active and passive transactions lies in the perspective from which we start. For example, for a bank, lending money will be a financial asset. From the opposite perspective, an entity’s customer will count on a financial liability.
What is Not Considered a Financial Liability?
- Contracts under which a good, right or service must be provided.
- Liabilities to governments, as they do not arise from a contractual obligation. For example, a tax liability to the Treasury.
- Each liability represents a payment obligation.
- It belongs to a specific economic agent, whether a natural or legal person.
- They arise from economic or financial transactions.
- They imply that the payment must be made in the future.
- The obligation is unavoidable. In case of non-payment, there is a default and the creditor can take action to demand payment.
- It is necessary to have liquid assets to be able to meet the obligation.
Types of Financial Liabilities
- Financial liabilities held for trading: they are issued for recovery in the short or medium term.
- Derivative financial liabilities: they arise as a result of an agreement based on the exchange of assets under agreed conditions.
- Financial liabilities at fair value: they arise when accounting mismatches are eliminated, when assets and liabilities are valued at the accounting close of a fiscal year.
Measurement of Financial Liabilities
It is customary to reflect liabilities in the current accounting at the value that is reasonable for the consideration received. However, as some may involve the payment of interest, financial liabilities may, for accounting purposes, be reflected at amortized cost.
Examples of Financial Liabilities
- Non-voting shares.
- Debts to individuals.
- Bonds and marketable securities issued by us, such as bonds and bills.
- Loan agreements.
In addition, there are other financial liabilities such as a contractual obligation to deliver an asset under conditions unfavourable to us, which may occur if we are required to transfer it at less than its current price or cost.
Practical Example of a Financial Liability
Let’s say XTIMe is in the business of making calendars. In order to offer your products for sale, you need to purchase a series of raw materials such as good quality paper and ink for printing. By the time you purchase these products from your supplier, you already have a debt, or financial liability.
Now let’s assume that this business is growing and has applied for credit so that it can purchase a larger space in which to operate. This credit is also part of the financial liability.
The only alternative to financial liabilities is to save, because yes, businesses must also save. In fact, their accounting will be much healthier if they can cover a significant part of their financing needs with their own resources. In fact, all debt generates interest, which ultimately leads us to pay more than the amount initially requested.
Is It Bad to Have Financial Liability?
When it comes to debt, we all want to get rid of it as quickly as possible. But in the business world, debt is normal and does not have to be negative. The important thing is to manage your assets and liabilities well and never let the latter exceed the former. this rule, which applies to the business world, can also apply to a domestic economy and, therefore, keep your debts as low as possible.
To do that good management we just referred to, when you take on debt, make sure you actually have enough assets to pay it off. If you manage and forecast your financial commitments well, your business can become very profitable. Financial and accounting terms are somewhat complex, but it is important to delve into them in order to better understand the financial situation of our business and manage it well.