Liability
Liability is an obligation that a debtor must bear and fulfill towards a creditor. Liabilities can exist in different forms and extents. Financial obligations are particularly common, but tangible assets of all kinds can also constitute liabilities. In the balance sheet, a liability denotes an item with known financial obligations, which should not be confused with contingent provisions.
Liabilities therefore play an important role above all in the balance sheet, but they also apply to general economic activity under the law of obligations. Examples of liabilities include wage payments by companies to employees, loans that must be repaid to a bank or other lender, electricity and energy expenses, and rent for commercial premises. The opposite of liabilities are receivables.
Importance of liabilities in accounting
Liabilities play a particularly important role in accounting. They are always recorded on the liabilities side, i.e. in the liability accounts of the balance sheet. Other obligations are also included in liabilities in accounting. This distinguishes liabilities from provisions. Obligations are easily and clearly quantifiable, must be transferred to a specific person for legal or economic reasons, and they represent an economic burden.
According to the German Commercial Code (Handelsgesetzbuch, HGB), certain liabilities must be reported separately on the liabilities side of the balance sheet. These include, for example, bonds and loans payable to banks, advance payments received that relate to orders placed, and liabilities from the acceptance of drawn bills of exchange. Liabilities from taxes, liabilities to affiliated companies, and liabilities to legal entities with common shareholdings must also be reported separately.
Liabilities in private accounting
In personal accounting, liabilities can be recognized on bank statements as debit entries — abbreviated as D or DEBIT (S or SOLL in German). They arise, among other things, from loan repayments, but also from regular expenses through direct debits and collection authorizations, cash withdrawals, and debit card payments.
These obligations are usually settled using the balance in the bank account, but there are also cases in which an overdraft or negative balance must be used when liabilities exceed the balance. Such loans greatly increase existing liabilities because they often come with interest charges of up to 17 percent. For this reason, it can be advisable in such cases to consider refinancing.
Impact of liabilities on business activity under the law of obligations
By many authoritative definitions, liabilities are specific obligations of a debtor towards a specific creditor. Although the law of obligations (Schuldrecht) is part of private law, it also concerns legal entities.
Liabilities should not be underestimated for companies. They are closely linked to a company's liquidity, creditworthiness, or solvency. All liabilities are therefore included in the liquidity calculation recorded in the liquidity plan. If a company no longer has sufficient liquidity or becomes illiquid, it must file for insolvency.
The higher the liabilities of companies and private households, the less financial leeway remains for investments. Therefore, it is always important to repay liabilities. This also helps avoid additional expenses in the form of attorney and court fees that can arise from the dunning procedure initiated by a creditor after missed payment deadlines.
Managing liabilities correctly
On both a private and corporate level, a distinction is made between relevant and irrelevant liabilities. Relevant liabilities are important for achieving certain improvements or optimizations. These include interest burdens in the context of loans. Interest charges are particularly annoying with large loan amounts because they could often have been avoided through thorough comparison of offers and subsequent analysis. If interest charges are nevertheless too high, refinancing is recommended.
You can also save cash by negotiating longer payment terms without incurring additional interest charges. With supplier credit, for example, you often do not have to pay interest for 30-, 60- or even 90-day payment terms, but you can reduce liabilities by taking advantage of an allowed cash discount (Skonto) for early payment. Depending on how high the cash discount is, you should weigh whether the interest cost over the payment period or the allowed discount is more advantageous.
The overdraft
On a private level, you should also learn to handle liabilities correctly. The best-known example is certainly the overdraft facility (dispo) that many banks grant. In many cases, it is advisable to use an installment loan instead of the overdraft. However, this also depends on the time period for which the external capital is needed. Therefore, it is always important to compare the potential costs and to compare the interest charges of overdraft or overdrawn accounts with the interest charges, fees, and other costs of installment loans.
Repayment of liabilities
When repaying liabilities, for example in finance purchases, you should always ask the seller to report the positive repayment to the Schufa. Schufa does record the taking out of loans, which can negatively affect a company's or an individual's Schufa record.
Repayment of liabilities can offset these negative effects. This is particularly important for companies, as their creditworthiness can suffer drastically from negative Schufa entries. For private individuals, a negative Schufa record is somewhat less important when taking out loans if other securities such as guarantors are available.
Conclusion: Repay on time and account correctly
To keep your liabilities in view and prevent them from becoming too burdensome, you should always aim to repay on time. Comparing offers, especially for loans, helps keep impending interest costs as low as possible. Many liabilities can be comfortably and painlessly settled through monthly repayments, as long as you commit to them.
Otherwise, not only do many additional costs arise, but also reputational damage and negative Schufa entries. Liabilities must also always be properly accounted for in a company's bookkeeping. Otherwise, a legal entity in the form of a company may face contractual issues and, to some extent, tax-related obstacles. Special attention should be paid to separate liabilities when preparing the balance sheet.