Essential Guide to Understanding Long-Term Liabilities
Long-term liabilities are a company’s financial obligations due more than one year in the future. To provide a clear picture of a company’s liquidity and its ability to settle current liabilities, the current portion of long-term debt appears separately on the balance sheet. These obligations, also known as long-term debt or noncurrent liabilities, are managed differently than short-term liabilities.
Key Takeaways
- Long-term liabilities extend beyond one year.
- They are distinctly marked on the balance sheet.
- They can be repaid through various business activities, both current and future.
Inside the World of Long-Term Liabilities
Residing in a specific section of the balance sheet, long-term liabilities may include items such as debentures, deferred tax liabilities, and pension obligations. They are financial obligations that are not due within the next 12 months or within the company’s operating cycle, which is the duration required to convert its inventory into cash.
However, some exceptions exist. For instance, current liabilities that are being refinanced into long-term should be shown as such if there is intent and evidence of the refinancing process. Additionally, liabilities due in the short term can be reported as long-term if there’s a corresponding long-term investment meant to cover the debt, provided the investment has sufficient funds.
Examples of Long-Term Liabilities
- The long-term portion of a bond payable.
- Present value of a lease payment extending beyond one year.
- Deferred tax liabilities extending into future tax years.
- Mortgages, car payments, and other loans for machinery or property, excluding payments due within the next 12 months.
Tip
The part of a long-term liability repayable within one year is classified as a current portion of long-term debt on the balance sheet.
Effective Use of Long-Term Liabilities
Long-term liabilities are vital for management’s financial analysis, especially when applying financial ratios. They help determine how the current portion of debt must be covered by liquid assets such as cash. Businesses can cover long-term debt through various activities like earned income, future investments, or new debt agreements.
Debt ratios, such as solvency ratios, examine total liabilities against total assets, giving insight into financial health. These ratios can focus on long-term liabilities, revealing a company’s leverage and finance structure.
Differentiating Long-Term and Short-Term Liabilities
Long-term liabilities, due in over one year, include mortgage loans, bonds payable, and long-term leases. Conversely, short-term liabilities, due within the current year, include accounts payable, accrued expenses, and the current portion of long-term debt.
Understanding the Current Portion of Long-Term Debt
The current portion of long-term debt represents the amount due within the current year. For example, although a mortgage spans 15 to 30 years, the payments due this year are considered the current portion and must be listed separately on the balance sheet as they need to be covered by current assets.
Placement in the Balance Sheet
A balance sheet showcases a company’s assets, liabilities, and equity at a specific date. After listing assets, current and long-term liabilities are presented, followed by equity. Long-term liabilities appear after current liabilities within the liability section.
The Final Word
Long-term liabilities, not due within the next 12 months, include loans for assets like machinery and equipment. They significantly influence a company’s financial structure and debt management strategies. Effective management and analysis of long-term liabilities are essential for maintaining robust financial health and strategic planning.
Related Terms: Current Liabilities, Debt Ratio, Debentures, Deferred Tax Liabilities.
References
- Papers.SSRN.com. Regina Laurens & Yuliana Tampang. “Long-Term Liabilities”.
