Liabilities are often realities of life

In financial matters, a liability is an obligation that you are required to make good on. Most times, it is an obligation that arose in the past but that places claims on you or your business in the future. A wide range of items qualify as liabilities. For individuals, liabilities are generally limited to credit card debt, mortgages, personal loans, car loans and other forms of borrowing. Contractual obligations to provide services in the future - if you accept payments in advance for a freelance project, for example - may also be classed as a liabilities, though these kinds of obligations are a little harder to quantify than those linked to debt.

For companies, liabilities include everything from wages owed to employees to loans and taxes. These liabilities form an important part of companies' accounting records. The more liabilities a company has in relation to its assets and revenues, the weaker its financial position. According to a long-used accounting equation, an owner's equity in a business is equal to its assets minus its liabilities.

Liabilities don't have to spring from financial sources; they can come from ethical or regulatory violations as well. Companies and individuals can incur liabilities by racking up fines, violating the law or incurring penalties for anti-competitive behaviour. A liability is anything that places financial demands on you in the future. At the same time, liabilities aren't always bad. Without taking on liabilities in the form of loans, businesses would find it far more difficult to finance growth and expansion plans. And without taking on liabilities, consumers wouldn't be able to drive the cars they want or live in the houses they want.

The legal definition of liability - obligations that are enforceable in course - is completely separate from financial liability. But it does often bear on financial matters. Companies, for example, are often set up as "limited liability" corporations. Under such a structure, the owners of the company can only be held liable for their personal investments in the firm should it go bankrupt. Creditors, in other words, cannot place claims on the personal assets of the owners to make good on the company's unfulfilled liabilities.

Liability is also an important concept in the insurance industry. When you pay insurance premiums, you are often exchanging cash for protection against potential future liabilities. Malpractice insurance shields surgeons from liability for operations gone wrong. Car insurance protects you from legal action stemming from accidents in which you were at fault. And companies can take out general liability policies that protect them from being held accountable for accidents on the job. [e-mail]