Analysing Financial Statements – Long Term Liabilities ( 5 of 6 )

In our continuation of our series of articles on Financial Statements, today we will touch on Long-Term Liabilities. The second classification of liability is called Long-Term Liability.

As mentioned in my last article, a long-term liability is money owed by a business that must be paid beyond a company’s operating cycle. In other words, it is debt that is due beyond a one year period.

Long Term pic 3

Current Liabilities Debts that must be paid in one year or less
Long Term Liabilities Debts that must be paid sometime beyond one year

Examples of Long Term Liabilities

  • 3 year business bank loan,
  • a 5 year business car loan,
  • a mortgage on a corporate building,

The Bakery’s Long-Term Liabilities on its Balance Sheet as of December 31, 2012 are as follows;

Long-Term Liabilities:
Mortgage on Building $21,257

Long Term pic 5

Mortgage on Building

“On July 1, 2012, the Bakery received a 10 year, $25,000 loan. The loan was needed to purchase a building. The building will be used to store inventory required by the bakery and also make the bakery items sold that the bakery store “.

The $25,000 dollars is a loan the baker must pay back to the bank. All loans are considered liabilities and since the loan is payable over 10 years, it is considered a long term liability. On December 31, 2012 the balance owning on the Mortgage is $21,257. As you can see, the loan has reduced from $25,000 down to $21,257 in half of one year (July to December, 2012). This reduction represents the amount of principal the company paid on the loan. Therefore, it’s safe to say the Bakery paid $3,743 in principal payments ($25,000- $21,257).

Total Liabilities 
Total Liabilities represent the sum of all Current Liabilities plus the sum of all Long Term Liabilities. Simply stated Total Current Liabilities plus (+) Total Long-Term Liabilities = Total Liabilities ($27,383 + $21,257 = $48,640). Below depicts the Liabilities of the Bakery as of December 31, 2012.

Current Liabilities:
Accounts Payable $14,524
Accrued expenses payable

  • Income Taxes Payable
$ 7,888
Short-Term Loan Payable $ 4,971
Total Current Liabilities $27,383
Long-Term Liabilities:
Mortgage on Building $21,257
Total Liabilities $48,640

As of December 31, 2012, The Bakery owes $48,640 dollars to other businesses (banks, governments and other businesses). $27,383 is required to be fully paid within one business year (short-term liabilities), while $21,257 is required to be paid later than one year (long-term liabilities)..

Why are Long-Term Liabilities important?

Companies have durable competitive advantage when they have enough earning power to pay off their long-term debt in less than three to four years; even better if companies are so profitable that they are self-financing when they need to expand the business or make acquisitions, so there is never a need to borrow large sum of money.

This concludes the Liabilities section of the Balance Sheet .The next component of the balance sheet is called the Equity section which we will cover in our final section of the article on anlaysing financial statement.

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Cheers!

Mumtaj

Programme Manager

Mind Kinesis Value Investing Academy

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