Liabilities and equity

What it means

Liabilities and equity are the sources that fund what the company owns. They divide into equity - members’ contributions and retained profit - and external sources: payables, loans and provisions.

On the balance sheet they face assets and the two totals always match. That is neither coincidence nor accounting sleight of hand: every euro of assets came from somewhere.

Besides equity and payables, this side also holds passive accruals and deferrals: accrued expenses and deferred income. They are not debts in the ordinary sense but amounts that belong to another period, such as rent received in advance for the whole of next year.

How it works in practice

The structure of this side says more about risk than the profit figure does. A preponderance of debt means bigger instalments and less resilience to a revenue dip; a high equity share means calm, but more expensive capital.

This is the side a bank reads: the ratio of own to borrowed funds, when the liabilities fall due, and whether share capital and profits cover accumulated losses.

When we analyse the statements we compare how long each source lasts with what it funds. If a company buys a machine meant to last ten years out of an overdraft, a short-term source is covering a long-term asset, and any cut in the bank’s limit becomes a liquidity problem even though the business is profitable.

What to watch out for

Negative equity is a serious signal - the company owes more than it owns, and the managing director acquires duties tied to over-indebtedness. The remedy is a member’s contribution or a turnaround, not waiting for a better year.

A loan from a member sits among the payables, and while the company is in crisis the Commercial Code bars repaying it for as long as the crisis lasts. A managing director who repays the member at the wrong moment risks the payment having to be returned and being personally liable for the damage.