What are Non-Current Liabilities?
Non-current liabilities can be defined as those financial obligations that are generally expected to be paid after a year. Typically, non-current liabilities are posted in a company’s Balance Sheet as a separate entry. Businesses tend to compare their non-current liabilities against their venture’s cash flow to analyse if it is financially equipped to meet its obligations in the long-run. The long-term liabilities are considered to be a potent way of assessing the solvency of a business venture.
Additionally, business entities tend to depend on long-term liabilities to meet their existing capital asset requirements or for investing in more profitable projects.
Some of the non-current liabilities examples include – long-term debt payable, long-term loans payable, deferred tax liabilities, long-term bonds payable, pension benefit obligations, long-term lease obligations, etc.
The non-current liabilities can be clubbed under five broad categories, namely –
- Bonds payable
- Long term notes payable
- deferred tax liabilities
- mortgage payable
- Capital lease
Types of Non-Current Liabilities?
An understanding of the different non-current liabilities tends to come in handy to identify or segregate long-term assets.
To elaborate, the following highlights the different types of non-current liabilities and helps to gain a better idea about it.
- Long-term borrowings
From the accounting perspective, long-term borrowings can be defined as the financial assistance that business entities avail in the form of credit. Typically, the repayment period for these kinds of borrowings is over a year. These borrowings are usually availed with the purpose to meet capital expenses. Additionally, they are also used when implementing strategic decisions about improving a firm’s operational scope or quality.
Notably, as per the norms of IFRS 9, business entities have to disclose their long-term borrowings in the accounting books at the amortised cost.
- Long-term lease obligations
These non-current liabilities are among the most common and vital expenses incurred by a business entity. Generally, such expenses help business entities to meet the asset-oriented requirements of a company effectively.
It must be noted that the payments directed towards these financial obligations are to be made as per IFRS’s norms and guidelines. Similarly, the General Acceptable Accounting Practices guidelines must also be considered while paying off these non-current liabilities. Likewise, business entities need to get their disclosure verified as per the latest applicable regulations.
- Secured and unsecured loans
Most business ventures tend to rely heavily on both secured and unsecured loans to meet their various daily operational requirements. For instance, business owners may avail a substantial loan amount to expand their existing business operation, to improve its operational efficiency or more.
Since such borrowings have to be repaid within a predefined period in future usually extending over a year, they form a part of non-current liabilities. Though there is a striking similarity between long-term borrowings and loans, these terms are not interchangeable when it comes to classifying the non-current liabilities list.
The primary point of differences arises from the fact that these borrowings can be availed from any retailer investors, lenders or non-banking financial institutions. However, advances are made against pre-sanctioned norms where business entities may or may not be required to pledge collateral securities.
As per the fundamental accounting principles, all individuals must acknowledge their aggregate expenses and revenue for a financial year in their accounting books. To further ensure the accuracy of the current year’s accounting balances, a provision is made to the books for unforeseen financial liabilities which are likely to occur.
It tends to help entities account for expenses that are incurred in the current year but would be realised in the following year. Notably, such provisions are not to be confused with general savings as their prime motive is to help formulate a more accurate and feasible profit and loss account statement.
Some of the most common examples of provisions are as follows –
- Severance costs
- Deferred tax
- Restructuring liabilities
However, entities can create a provision to meet future liabilities subject to a few conditions, some of which are mentioned below.
- There must be a 50% probability that the reason this provision was created for would occur.
- The said obligation is likely to push the balance sheet date ahead or may give rise to a constructive or legal liability.
- A significant attempt must be made by the company management to regulate the said obligation.
- The obligation accounted is deemed to be financially draining in the event of its occurrence.
- Deferred tax liabilities
These non-current liabilities are created to bridge the time gap between the accrual of tax and its payment. Different accounting methods are used to achieve it, and income disclosure takes into account this differential payment over time.
This way, deferred tax liabilities indicate that entities account for the tax liabilities in a different time table than the fulfilment of tax obligations, thus impacting the income. Based on this long-term liability, the tax liability of a business venture is set off over a pre-decided number of financial years.
- Derivative liabilities
Share issuing companies mostly have to account for these types of liabilities. Typically, such liabilities arise when a company’s derivative instruments stand at a mark to negative market value. Consequently, the derivative instruments are considered to be a liability and are treated accordingly in the accounting books.
- Other non-current liabilities
Typically, other non-current liabilities can be described as a group of long-term liabilities that cannot be explicitly identified under non-current liabilities. The most common examples of such financial obligations include bonds, product against warranty, deferred compensation, revenues and pension liabilities.
In a nutshell,
Non-Current Liabilities = (Long term borrowings + Long term lease debts + Secured and unsecured loans + Provisions +Deferred tax liabilities + Derivative liabilities + Other non-current liabilities)
Importance of Non-Current Liabilities
Though most lenders prioritise current liabilities and short-term liquidity over non-current liabilities, the latter plays a vital role in deciphering a business venture’s capability. For instance, such liabilities are used to measure a venture’s solvency and help to figure out if a business is adequately leveraging it or not.
Further, it is used to analyse the stability of a venture’s cash flow. By matching the total non-current liabilities against cash flow, one can effectively find out a venture’s financial ability to meet long-term obligations. For instance, if the cash flow is significantly steady; it means the business venture would be able to bear its debt burden successfully with minimised chances of default.
A fair idea about a company’s cash flow stability and use of leverage also comes in handy for its potential investors. It directly helps them analyse if doing business with a company would prove profitable for them or not.
To elaborate, if a company tends to leverage its key resources to meet account payables, creditors may not deem it profitable to associate with them. On the other hand, stagnant cash flow, coupled with the use of excessive leverage, may deter investors from investing in such a business’s venture.
Nevertheless, to understand how non-current liabilities help to gauge such vital aspects, investors and business entities must assess specific ratios as well.
Different Financial Ratios Involving Non-Current liabilities?
Specific financial ratios not only help to figure out a venture’s debt-paying capability but also help gauge its potential as an investment avenue.
Here’s a list of a few of such financial ratios which involve non-current liabilities.
- Debt ratio
The said ratio compares a company’s aggregate liabilities to its total assets and tends to offer a fair idea of how often it resorts to liability leveraging. A lower percentage indicates that a company is reducing this leverage and has a firm footing for equities. Similarly, a higher ratio indicates that it is more likely to be exposed to financial risk.
Formula: Debt ratio = Total Liabilities/ Total Assets
- Debt to equity ratio
The ratio is arrived at by comparing the total equity of a venture to its total debt. A significantly high ratio signifies that a business venture is not being funded with enough equity. Business owners may take a cue from such outcomes and meet the shortcomings accordingly.
Formula: Debt-to-equity-ratio = Total Liabilities/Total shareholders’ Equity
- Cash flow to debt ratio
This ratio helps gauge how readily a business venture can pay off its existing debt by utilising its cash flow.
Formula: Cash flow to debt ratio = Cash flow/Total liabilities
A higher ratio indicates that a business venture is financially sound and is capable of accelerating its debt payments if deemed necessary. On the other hand, a lower ratio suggests a weak financial standing.
Difference between Various Liabilities
The primary difference between non-current liabilities and other types of financial obligations of a business can be highlighted as follows.
|Type||Current Liabilities||Non-Current Liabilities||Contingent Liabilities|
|Definition||It comprises those liabilities which must be written-off within a financial year or business cycle. They are also known as short-term liabilities.||These liabilities are usually written-off in more than one year or business cycle.They are also known as long-term liabilities.||They mostly comprise obligations which may or may not be realised in a given financial year.|
|Treatment in books of accounts||It is posted on the right side of the Balance Sheet above the ‘Non-Current Liabilities’.||They are recorded on the right side of the balance sheet below ‘Current Liabilities’.||It is recorded twice in a Balance Sheet. The first treatment is recorded as an expense under the Income Statement, and the second is recorded on the right side of the Balance Sheet as well.|
|Examples||Some of the examples of current liabilities include accounts payables, short-term loan, trade payables and outstanding dues.||Debentures, mortgage loans and bonds are some of the non-current liabilities examples.||Guarantee for loans, lawsuits and claim against product warranty are some of the examples of contingent liabilities.|
Hence, it can be said that non-current liabilities play a vital role in analysing a business venture’s current as well as probable financial standing. It also comes in handy for investors to highlight a business’s scope as an investment avenue. Similarly, by balancing one’s liabilities frequently, business owners would also be able to make necessary financial decisions aligned for improved management.