Non current liability

From CEOpedia | Management online

Non-current liabilities, also known as long term liabilities are a part of a company's balance sheet. What differs them from the current liabilities is the payment period of the debt. The settlement period for non-current liability is longer than a year. If the time is shorter or equal to one year, then a liability should be classified as a current liability. As most of the non-current liabilities are connected with an interest, the accumulation of the interest itself should be classified as current liability[1]. The debt can be also paid in installments. At the beginning of each year, the payment for upcoming year should be transferred from the section of non-current to current liabilities. As a good example it can be mentioned bonds, mortgages or notes payable, which maturity date is longer than one year. One of the most common way to gain additional source of funds for a company are long-term debts, which classify as non-current liability. It is so, because for this kind of financing the cost - interest - is often fixed which eliminates the risk of changing payment for the financing. Moreover, long-term debt can be used as a leverage. The cost doesn't change depending on the company's income, which allows to achieve greater earnings in a high-revenue year than it would be with variable-cost financing. Additionally, the long-term debt cost (interest) can be classified as a business cost and deducted from the company's income which reduces the amount of income tax payable by the company. There are two the most common non-current liabilities mentioned below[2]:

  • Mortgage payable
  • Bonds payable

Mortgage payable

This type of non-current liability is created, when a natural person decides to secure its loan with owned real estate. In case of insolvency from the creditor's side, the lender has the right to sell the property and the proceeds obtained from the transaction are used to cover the debt. If the value of sold property is higher than the value of remaining debt, then the lender becomes a general creditor for the disparity and has to pay this amount back to the creditor (natural person)[3].

Bonds payable

Bonds payable are obligations towards the buyer, where a company (or the government of a country) promises to buy the paper back for a certain amount in a certain time. Along with those promises, the issuer also declares to pay an interest periodically on the remaining principal. There are several types of bonds which will be described below. Debenture bonds - In this type of bonds, the buyer is protected only by the credit rating of the issuing company. However, there may be some requirements which additionally protect the buyer. These may include the requirement to maintain specific level of working capital ratio or immediate process of buy-back if the company will not be able to pay the interest to the buyer. Income bonds - Those bonds characterize with the rules of interest payment. If the issuing company records low level of earnings, then the payment of interest may be cancelled or postponed. If the payment of the interest is postponed to a future date, then such bond is called cumulative[4]:

Examples of Non current liability

  • Bonds: Bonds are a form of debt that companies issue in order to raise capital from investors. Bondholders are lenders to the company, and the company must pay interest to the bondholders at regular intervals, as well as repaying the principal amount at maturity.
  • Long-term loans: A long-term loan is a loan that has a repayment period of more than one year. These loans can be secured or unsecured, and are used for major purchases such as real estate or machinery.
  • Lease obligations: A lease obligation is a contractual agreement between a tenant and a landlord, in which the tenant pays a fixed amount of money each month in exchange for the use of the property. This lease obligation typically has a longer-term than one year.
  • Deferred taxes: Deferred taxes are taxes that a company has not yet paid, but which it expects to pay in the future. These taxes are recorded as a non-current liability on the balance sheet.
  • Pension liabilities: Pension liabilities are an obligation that a company has to its employees once they have retired. This liability is typically recorded as a non-current liability on the balance sheet.

Advantages of Non current liability

Non-current liabilities are a great source of financing for a company, providing some advantages:

  • They provide a company with a steady and reliable source of financing, allowing them to invest in resources and projects that may not be able to be funded with current liabilities.
  • Non-current liabilities are also beneficial for companies that need to finance large investments or projects, as the payments are made over a longer period of time, allowing for more manageable cash flow.
  • The interest rates on non-current liabilities are usually lower than those of current liabilities, providing the company with a cost-effective form of financing.
  • Non-current liabilities also provide a company with flexibility when it comes to repaying the debt, as the company can choose to pay the debt off in installments or in lump sums.
  • Non-current liabilities also provide a company with access to capital that may not be available through other sources of financing.

Limitations of Non current liability

  • Non-current liabilities do not generate immediate cash flow. As such, they may not be able to cover immediate costs or pay off current liabilities.
  • Non-current liabilities are more expensive than current liabilities, as they may come with higher interest rates or require more collateral.
  • Non-current liabilities may not be paid off until their due date. This can make them more difficult to manage and maintain, as the company needs to keep track of the payment schedule and make sure all payments are made on time.
  • Non-current liabilities may also be difficult to liquidate in the case of an emergency. This can limit the company's ability to access funds quickly and efficiently.
  • Finally, non-current liabilities can also create financial risks for the company, as they may be more difficult to predict and manage. This can lead to higher levels of uncertainty and risk for the company.

Other approaches related to Non current liability

One approach related to non-current liabilities is to analyze their impact on the liquidity of the company. This involves understanding how the liabilities will be paid off, how much interest will be paid, and how the liabilities will be affected by changes in the company's financial environment. Other approaches include:

  • Understanding the company's long-term debt structure, which includes understanding the maturity dates, principal and interest payments and other obligations associated with the debt.
  • Analyzing the company's debt-to-equity ratio, which measures the proportion of debt to equity and is used to assess the company's risk.
  • Evaluating the company's ability to service its debt, which involves analyzing the company's cash flow and other sources of income.
  • Assessing the company's creditworthiness, which involves obtaining credit ratings and understanding how the company's creditworthiness affects its ability to access credit.

In summary, non-current liabilities must be carefully analyzed to understand their impact on the company's liquidity, debt structure, debt-to-equity ratio, ability to service its debt, and creditworthiness. Understanding these factors helps to assess the company's financial position and ability to meet its future obligations.

Footnotes

  1. ↑ NCERT,(2013),Accountancy: Company Accounts & Analysis of financial Statements, New Delhi, p. 203
  2. ↑ M. P. Griffin,(2015), How to Read and Interpret Financial Statements: A Guide to Understanding What the Numbers Mean to You, AMA Self-Study
  3. ↑ R. J. Rosen, (2011), Competition in mortgage markets: The effect of lender type on loan characteristics, p. 3
  4. ↑ M. P. Griffin,(2015), How to Read and Interpret Financial Statements: A Guide to Understanding What the Numbers Mean to You, AMA Self-Study


Non current liability — recommended articles
Evergreen Loan — Current portion of long-term debt — Assets funding strategy — Debt extinguishment — Credit Facility — Cash and cash equivalents — Unsecured Note — Customer deposits — Quick assets

References

Author: Justyna Piekorz

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