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Understanding liabilities of company
Welcome to this session on Understanding Liabilities
We are all investors in company via equity shares.
Listed companies regularly release reports and updates about the company.
Among all such updates, financial statements are important.
In particularly, the quarterly reports and annual reports are a source of vast information.
As investors, we want two important financial statements:
1. Balance Sheet
2. Profit and Loss Statement
From where can we download these statements?
We can download the statements from:
1. The company website (Investors section / Annual Report) or
2. From the stock exchange website or
3. Ministry of Corporate Affairs website
The Balance Sheet gives us information such as assets, liabilities, and the shareholders equity.
The Profit and Loss Statement helps us understand the profitability of a company.
The Balance Sheet is divided into two parts:
1. Equity and Liabilities
In any typical balance sheet, the total assets of company should be equal to the total liabilities of the company.
Liabilities are some important numbers we can analysis from the Balance Sheet of the company.
Every liability is an obligation for the company.
The company is bound to make repayment and settle the liabilities sooner than latter.
Simply said, these are loans or money taken from external sources and need to pay back.
Who wants liabilities? i.e Loans?
We do not want to go for a loan because:
1. Pressure on us to repay the loan
2. Pressure to repay interest
3. Tension that the lender will take our assets
When the company we invested has some liabilities, we need to understand what are the liabilities ..
and for what purpose were they used?
So, you need to understand why the company has taken loans in the past..
and if it is repaying on time or not?
And what is impact of interest outgo?
And when is the company planning to be a debt free company?
Now, what is debt free?
A "debt free" is a company which has no debt i.e no loans
No debt means No interest payment burden
But you should understand why the company is debt-free?
Is the company not given a loan because of some reason? Like bad promoter, bad credit rating, poor quality of assets etc.
It is difficult to find good quality companies that are debt free or only having meaningful liabilities.
So understand these factors before investing.
Rule #27: Prefer companies with that are debt free or having meaningful liabilities
Types of Liabilities
Liabilities are of two types:
1. Current Liabilities and
2. Non-current Liabilities
Current Liabilities = Payments that company has to make in less than 1 year
Current = On going = soon
i.e payable immediately or in less than 365 days
Types of Current Liabilities
1. Short term borrowings (Example Overdraft account with bank)
2. Trade payables (Example: Payments to be made to suppliers etc.)
3. Other current liabilities = payments to be made because of statutory requirements and obligations (Example: Tax payments, penalties etc.)
4. Short-term provisions = Keeping some funds aside for employee benefits such as gratuity, leave encashment, provident funds etc that are payable in less than 1 year.
Now lets see Non Current Liabilities
Non "Current" = Payable after 1 year (or beyond 365 days)
Three types of Non Current Liabilities
Type 1. Long term borrowing (Important) ~ Used in computing financial rations
1. Deferred payment liabilities and
2. Interest free sales tax deferment
Type 2: Deferred Tax Liability = Some money kept aside for payment of tax next year
Type 3: Long term provisions = money set aside for employee benefits such as gratuity; leave encashment, provident funds etc.
1. Download the balance sheet of a company that you have invested and identify the various types of liabilities.
2. What is the interest burden of various companies that you are invested? Was it going up or down quarter over quarter?
- Prefer companies that make profits (Rule 6)
- Debt-free / Low-debt / Virtually-debt free companies (Rule 10)
- High Beta Stocks (Rule 24)
- Operating Profit Margin
- Promoters and Shareholding Pattern (Rule 28)
- Promoter Pledging (Rule 29): What it is? And is it good or bad for the investors?