Liabilities

What are liabilities?

Liabilities are a company's debts, that is, all obligations towards third parties that are fixed in principle and in amount. They appear on the liabilities side of the balance sheet.

Provisions must be distinguished from them: there, the obligation is probable but the amount or timing is uncertain, for example in the case of ongoing litigation.

The breakdown under Section 266 of the German Commercial Code (HGB)

• Bonds
• Liabilities to banks (credit institutions)
• Payments received on account of orders
• Trade payables (liabilities from goods and services delivered)
• Liabilities to affiliated companies and to companies in which a participating interest is held
• Other liabilities, including taxes and social security

Why the maturity matters more than the amount

The notes to the financial statements state the remaining terms: up to one year, one to five years, more than five years. That is where the real information lies.

Example: Two companies each have liabilities of EUR 800,000.

• A: EUR 600,000 bank loan with a remaining term of seven years, EUR 200,000 owed to suppliers.
• B: EUR 750,000 falling due in the short term, of which EUR 300,000 is an overdraft.

The same balance sheet total, a completely different situation. A has financing; B has a problem that will become visible within a few months.

The key ratios

• Equity ratio: equity divided by balance sheet total. Banks pay close attention to it.
• Debt ratio: debt capital divided by equity.
• Dynamic debt ratio: net debt divided by cash surplus. It shows in years how long it would take to pay off the debt. The most informative of the three.

Common mistakes

1. Looking only at the total. The maturity structure determines the risk.
2. Using the overdraft as permanent financing. Expensive and callable at any time, the least secure form of debt capital.
3. Overlooking obligations that must be reported on the balance sheet. Leasing, rent and contingent liabilities sometimes appear only in the notes and are still taken into account.
4. Underestimating tax liabilities. They rank first and, in the event of default, can be enforced uncomfortably quickly.

Frequently asked questions

How do they differ from provisions?

Liabilities are fixed in principle and in amount. Provisions concern probable obligations of uncertain amount or uncertain timing.

How much debt is reasonable?

There is no universally valid limit. A practical benchmark is the dynamic debt ratio: if it stays permanently above five years, things become difficult with banks.

What happens to them in a funding round?

Investors usually calculate with company values on a debt-free basis. Existing net debt then reduces what reaches the shareholders, a point that regularly leads to misunderstandings in valuation discussions.

The Roemer Capital view

Before a round, we always prepare a list of all liabilities by maturity, with the collateral and covenants from the loan agreements. The reason is the covenants: many agreements contain clauses that take effect on a change of shareholders. Such a clause, if it first turns up during due diligence, can delay a round by weeks.