What are Long Term Liabilities on the Balance Sheet?
Long Term Liabilities, often referred to as Non-Current Liabilities, arise due to a liabilities not due within the next 12 months from the Balance Sheet Date or the Operating Cycle of the company and mostly consists of Long term Debt.
The term ‘Liabilities’ in a company’s Balance sheet means a particular amount which a company owes to someone (individual, institutions, or Companies). Or in other words, if a company borrows a certain amount or takes credit for Business Operations, then the company has an obligation to repay it within a stipulated time-frame. Based on the time-frame, the term Long-term and Short-term liabilities are determined. Long-term liabilities that need to repay for more than one year (twelve months) and anything which is less than one year is called Short-term liabilities.
For example – if Company X Ltd. borrows $5 million from a bank with an interest rate of 5% per annum for 8 months, then the debt would be treated as short-term liabilities. If the tenure becomes more than one year, then it would come under ‘Long-Term Liabilities’ on the Balance Sheet.
List of Long-Term Liabilities on Balance Sheet
Based on the nature of the Liabilities taken by a Company, here is the list of Long-term liabilities on the Balance Sheet:
#1 – Shareholders Capital
Shareholders are the real owner of a Company and can be classified into two categories, like Preference shareholders and Equity shareholders. Preference Shareholders are given preference during the time of distribution of profits (gets the dividend if there is also a loss). In contrast, Equity shareholders get dividends only when there is a profit. On the other hand, Equity shareholders have voting right, unlike Preference shareholders. The initial capital or the ‘Seed Financing’ required for the business basically comes from the Shareholder’s pocket, and the total capital amount can be dived into the total number of shareholders based upon their contributions to the capital. The risk-to-reward ratio is allocated as per the capital contribution. For example- Suppose Company A has been funded by three investors X, Y & Z with the capital contribution of $2000, $3000 and $5000, and then the profit would be shared based on 2:3:5.
Reserves& Surplus is another part of the Shareholders’ equity, which deals with the Reserves part. If a Company makes constant profits, then the pile of profits at a given point of time would be termed as ‘Reserves and Surplus.’ For example, if a Business unit delivers Net profits after tax (after dividend distributed to shareholders) for the first three years @ $11,000, $80,000 and $95,000. Then the total reserves would be $(11000+80000+95000) or $285,000 after the third Financial Year.
Thus, we can say
#2 – Long-Term Borrowings
Below is the long term liability example of Starbucks Debt.
source: Starbucks SEC Filings
Borrowings are an integral part of a business; the entire capital cannot be funded only from Shareholder’s capital. Generally, high-capital intensive requires funds at different stages. Thus, to ensure smooth operations, a Business unit takes a loan from a financial institution or any bank or any individual or group of individuals. A loan that is repayable after 12 months, along with interest, is known as Long-term borrowings. Types of long-term borrowings are –
- Bonds or Debentures, which bear a specific amount of fixed interests, are generally borrowed from the market bearing a fixed amount of interest repayable by the Company. Bondholders are not bothered with the profitability of the company. They are obliged to get the money until the company is declared as insolvent.
- Other than Bonds, Borrowings can be made from institutions or Banks (Term as a loan) with a pre-decided date. Failure to pay the loan within the stipulated time, along with interest, could force to pay a penalty fee by the company. Thus, a high borrowing amount is generally a bad signal for a company, and it becomes worse if Business cycle changes.
- Bonds are rated by rating agencies like Moody’s, Standard & Poors, and Fitch depending on how safe the bond is – Investment grade or non-investment grade.
#3 – Deferred-Tax Liabilities
Tax liabilities can be terms as the tax which a company is obliged to pay in case of profits made. Thus, when a company pays a lesser tax on a particular financial year, the amount should be repaid in the next financial year. Till then, the liability is treated as the deferred tax, which is repayable with the next financial year.
For example, Company HR Ltd. made a profit of $20,000 in FY17-18 and paid a tax of $5000 (assuming 25% tax rate), but later the company realized that the tax-slab is 28%. Then, in this case, $600 has to be paid along with next year’s tax payment.
#4 – Long-Term Provision
Provisioning a certain amount generally means the allocation of a certain expense or loss or bad-debt in respect to the future course of action by the Company. The item is treated as a loss until the loss is accounted for by the company. For example, – Pharmaceutical companies assume certain losses regarding patent rights as all the Research & Development part is related to the approval of the patent of medicines. Similarly, lawsuit charges & Fines from pending investigations come under the same heads in the Balance-sheet. For example, if a Bank expects a certain amount of Loan, which is most unlikely to recover, then the Loan amount would be treated as ‘Bad Debts.’
The above example shows that the company Hindalco Industries is doing business in Aluminium extracting, and the manufacturing of Aluminium finished products has raised its equity base from INR 204.89 Cr. in FY16 to INR 222.72 Cr. In FY17. The above equity inflow results of a higher equity base, which is an outcome of the newly issued Equity share.
Because of the profitability of the Company, the Reserves amount shoot up from INR 40401.69 Cr to INR 45836 Cr. However, the Long-term Debt ratio has reduced from INR 57928.93 Cr. to INR 51855.29 Cr. which is almost 10.5 % from the previous year, and it’s a healthy sign.
Deferred Tax, Other Liabilities on the balance sheet, and Long-term Provision have, however, decreased by 2.4%, 2.23%, and 5.03%, which suggests the operations have improved on a YoY basis.
The risk to Investors vs. Long Term Liabilities
The below graph provides us with the details of how risky these long term liabilities are to the investors.
- We note that the common stock is the riskiest to the investor, whereas short-term bonds are the least risky.
- In between comes the others like senior secured facility, senior secured notes, senior unsecured notes, subordinated note, discount note, and preferred stocks.
Importance of Long-Term Liabilities on the Balance Sheet
- Long-term Liabilities on the balance sheet determines the integrity of the Business. If the Debt part becomes more than the Equity, then it’s a reason to worry regarding the efficiency of the Business Operations. Such liabilities need to be controlled in the near future.
- Higher provisioning also indicates higher losses, which are not a favorable factor for the company. Higher expense causes shrinking of profits. On the other hand, if a company assumes a higher provision than the actual number, then we can term the company as a ‘defensive’ one.
- Equity share capital, along with reserves and debt, determines the cash flow of the company. Purchase of assets, new branches, etc. can be funded from Equity or Debt.
Long-Term Liabilities Video
This has been a guide to what is Long-Term Liabilities on the Balance Sheet and its definition. Here we discuss the list of long-term liabilities, including the long-term debt, shareholders equity, long-term provision, and deferred tax liabilities along with practical examples. You may also have a look at these articles below to learn more about accounting –