The primary difference between Liability and Debt is that Liability is a wide term which includes all the money or financial obligations which the company owes to the other party, whereas, the debt is the narrow term and is part of the liability which arises when the funds are raised by the company by borrowing money from the other party.
Difference Between Liability vs Debt
Every business carries out various activities and transactions which are recorded in different financial statements of the company. Business activities that result in transactions are classified under broad headings in financial statements like – assets, liabilities, owners’ equity, revenue, expenses, etc.
In this article, we will look at two elements in a balance sheet of a company, namely – ‘liabilities’ and ‘debt.’
Liability vs. Debt Infographics
Here we provide you with the top 6 difference between Liability vs. Debt.
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Liability vs. Debt – Key Differences
The key differences between Liability vs. Debt are as follows –
- The terms ‘liabilities’ and ‘debt’ have similar definitions, but there is a fundamental difference between the two. Liabilities are a broader term, and debt constitutes as a part of liabilities.
- Debt refers to money that is borrowed and is to be paid back at some future date. Bank loans are a form of debt. Hence, it only arises out of borrowing activities. Whereas, liabilities arising out of other business activities as well. For example, accrued wages are payments to employees that have not been paid yet. These wages are obligations on the part of the company and are categorized as a liability.
- Liability includes all kinds of short-term and long term obligations, as mentioned above, like accrued wages, income tax, etc. However, debt does not include all short term and long term obligations like wages and income tax. Only obligations that arise out of borrowing like bank loans, bonds payable constitute as a debt. Therefore, it can be said that all debts come under liabilities, but all liabilities do not come under debts.
- The debt of a company exists in the form of money. When a company borrows money from a bank or its investors, this money borrowed is considered to be debt for the company. On the other hand, liability does not necessarily have to be in the form of money. Liability can be anything that imposes a cost on the company. Future expenses like salaries to employees or payment to suppliers are liabilities for the company and not debt.
Liability vs. Debt Head to Head Difference
Let’s now look at the head to head the difference between Liability vs. Debt.
|Points of Comparison – Liability vs. Debt||Liability||Debt|
|Definition||Any money or service that the company owes to another individual or party.||Similar to liabilities, the term debt also refers to an amount of money that a company owes to another party.|
|How does it arise?||1. Liabilities of a company arise due to its financial obligations that occur while conducting business.
2. Businesses have to raise funds to buy assets, and liabilities are a result of a business’ fundraising activities.
|1. The debt arises when a company raises funds by borrowing from another party. This debt is to be paid back at a future date, along with an interest amount.
2. Hence, debt can also be defined as a type of liability. Many companies raise debt for financing large purchases.
|Where are they recorded on a balance sheet?||Liabilities are recorded on the right-hand side of the balance sheet and include various elements under it. They are future obligations on the part of the company that will be settled through transfer money, goods, and/or services.||Debt is a type of liability. Hence, it is also recorded on the right-hand side of the balance sheet.|
|Sub-categories||In the balance sheet of a company, liability appears under two sub-categories, namely, current liabilities or short term liabilities and non-current or long term liabilities.||Similarly, there is short term debt (which shows under short term liabilities) and long term debt (shows under long term liabilities).|
|Ratios||Liquidity ratios help us measure the ability of the company to pay its short term as well as long term obligations.||Leverage ratios or debt ratios measure the debt levels of the firm. These ratios help assess how much the firm is dependent on debt. It also helps us understand the firm’s ability to meet its financial obligations.|
|Examples||Typical elements under Liabilities in a Balance Sheet Liabilities Noncurrent liability Bank notes payable Deferred income tax liability Post-employment benefits liabilities Other non-current liabilities Provisions.||As an example, let us say Company ABC wants a massive loan of $10 million. Instead of investing shareholder’s equity or selling its stock, it decides to raise funds or capital by issuing a 5-year bond to investors. Here, Company ABC is borrowing money, and hence, these funds constitute as debt, which will have to be paid back to creditors with interest at a due date in the future.|
|Current liabilities: Notes payable Current income tax liabilities Accounts payable Accrued and other current liabilities Unearned revenue||As explained above, a company can take a loan to raise funds by issuing debt instruments. Similar to any other loan, while issuing debt, the company must keep its assets as collateral. It means that debt issued by the company is a liability for it since the lender has to be paid back at a future date, and the lender also holds a claim over the collateralized assets.|
Hence, liability and debt and closely related concepts and may even be used interchangeably. But as discussed above, there are some critical differences between the two. Liabilities are a broader term, and debt is a type of liability. Liabilities arising out of the daily operations of the company, which results in an expense or obligation to be fulfilled in the future. Whereas debt only arises when a company borrows money from another party. These are two essential concepts as investors closely monitor how much debt the company owes and what are the future obligations in the form of liabilities that the company has.
This article has been a guide to Liability vs. Debt. Here we discuss the top differences between Liability vs. Debt along with infographics and comparison table. You may also have a look at the following articles –