Before a company receives any kind of borrowed funds , whether it be a loan from a financial institution or an individual’s investment, its financial situation is carefully analyzed to determine whether it is able to cope with its obligations on time. Almost all the information that is necessary to draw the first conclusions can be obtained by analyzing the balance sheet liability. However, first you need to give a definition.
Liability balance sheet is the total amount of sources of funds that are presented in the balance sheet. The liability has two main interpretations in world practice, which are conditionally referred to as legal and economic. The balance sheet liability in the first case is interpreted as a set of obligations of the enterprise with respect to persons who directly or indirectly provide it with its own funds (the share of owners in this case is treated as a liability in the conventional sense). In the second case, liability is treated as a combination of sources of funds. In addition, a liability is a plan for distributing the estimated value of assets.
Thus, the liabilities side of the balance sheet reflects the company's decisions on the choice of sources of external and internal financing of investment decisions made, the result of which are assets acquired by the enterprise. In accordance with this approach, three main sections of the balance sheet liability were formed.
The first section, called "equity" contains information regarding the funds that were invested in the company by its shareholders. This can happen in the form of investments in the authorized capital during the creation of the company, the repurchase of certain shares after the company was created, as well as through retained earnings. Quite often, the profit received by the enterprise is not completely distributed among shareholders in the form of dividends, but is postponed to expand the company's activities - this is also considered a source of financing. A large share of equity is a good "airbag" for the company from possible financial risks.
In its second part, the liabilities side of the balance sheet contains information on long-term liabilities that the company has to external parties. Such lenders are not interested in the economic success of the enterprise, as they provide money in debt, which must be repaid regardless of whether the company has profit. However, before receiving a long-term loan, in the form of a redemption of bonds, leasing, a loan, etc., the company must prove that it will be able to repay it on time and with the percentage agreed in the contract. The more long-term liabilities a company has, the less its chance to get a new loan.
And finally, the third section is short-term obligations, that is, obligations that must be repaid by the company within a year. Basically, they include commercial loans and those obligations for which the repayment period in the current year is suitable. The analysis of the balance sheet liability in this case should be carried out in parallel with the analysis of its asset, since it is important for us to determine whether enterprises can repay their debts using assets. For this, liquidity ratios are calculated. If these indicators are at a level lower than the level recommended by financial analysts, the company may experience serious financing problems.
Thus, the balance sheet liability contains all the information necessary to analyze the financial situation of the enterprise and its financial prospects, so for an experienced financier just looking at it is enough to read the enterprise as an open book.