Liabilities (when it comes to balance sheets) is just a fancy word for debt. Just as it is with your own finances, not all debt is bad. Companies have to borrow money just to function.
Current liabilities are all debts that are due within the year. While companies can drown in long-term debt, these debts are the most urgent. If a company can’t refinance the debt or come up with a large amount of cash, you can expect a bankruptcy filing to come soon.
You’ll notice that some categories of current liabilities have mirror images on the “assets” side of the balance sheet. Just as a company has accounts receivable, it could have accounts payable, which is money it owes for recent purchases.
Short-term debt is pretty self explanatory. Companies often borrow money for a very short amount of time to account for temporary deficiencies. If, for example, a company just sold several airplanes for several million dollars but it hadn’t collected the money yet, it might need a short-term loan to make payroll.
The market for commercial paper, one example of short-term debt, froze up last year, soon after Lehman Bros. went bankrupt. So even profitable companies were at risk of bankruptcy simply because of timing issues regarding their debt payments.
Long-term debt that is coming due within the year is also a current liability. Unlike, say, a mortgage, where you pay down the debt and pay interest simultaneously, when companies issue bonds, most of the time they pay the interest only. Then, when the debt matures, they pay the principal back.
So if a company issued $100 million in bonds at 6% interest for 30 years, they’d pay those bond holders $6 million a year in interest. But after 30 years, the entire $100 million comes due.
Most of the time, companies can easily refinance that debt at current interest rates. Right now, while the credit market has gotten better, they still might have to accept unfavorable terms for the new loans.
Even if a long-term debt isn’t technically a current liability, it makes sense to check the footnotes of the balance sheet to see when the rest of the debt is coming due. If it’s within the next few years, just understand that that could be a huge, erm, liability for the company as it looks to refinance.
This is simply any debt that comes due outside of the year. The less long-term debt you see on the balance sheet, the better. While companies might have to make short-term borrowings all the time, it’s better if you can find companies that don’t have to finance things long-term.
If a company doesn’t carry any long-term debt, it indicates that its earnings power is strong enough that it can self finance major improvements needed for the business. Depending on the industry, this might not be feasible. So you can often glean a lot about a company’s management by comparing debt to other company debt in the industry.
Excessive long-term debt can also come from a leveraged buyout, where the purchaser borrows a ton of money against his target’s current cash flow. The Tribune Company, for example, while very profitable, is under a mountain of long-term debt because of its buyout by Sam Zell.
These include deferred income tax and minority interest. Deferred income tax is tax that the company has been able to hold off on paying for one reason or another. Minority interest is shown on the balance sheet when one company has acquired another. If, for example, Coca-Cola bought 90% of Joe’s Soda Shack, it could put 100% of Joe’s assets and liabilities onto its balance sheet. But to show that it didn’t own the entire company, the value of that remaining 10% is filed under Minority Interest.
That’s it. Subtract the total liabilities from the total assets and you get shareholder’s equity (i.e. book value). I’ll explain why that’s important and write about the ratios that investors look at on a balance sheet when I get back on Monday.
— Joe Light