Question

The ability for a company to meet its liability obligations is important when assessing financial stability. Consider what high liability balances might indicate about a company and explain the pros and cons of this type of balance.

Answer 1

While assessing financial liability, the liability part of the balance sheet is analysed, which consists of long term liability and short time liability.

High liability balance in a Balance sheet is considered negative aspect of the business as it indicates that the entity is debt ridden. It is also viewed that if the entity is not able to repay its debt on time, then it might lead to shutting down off business.

Other than above, it indicates a high debt ratio and low equity. Also, insufficiency of cash and bank balance (that is liquidity) may be the reason to get the debt.

High liability balance is itself disadvantageous to the entity due to above factors. Also, it creates a negative image in the minds of stakeholders and credit rating agencies.

Only benefit of taking debt is that ,when the interest rate is lower than the return on equity. Also, tax benefit on interest on loan is taken by the entities.

In nutshell, we can say that, high liability balance is not beneficial for the business.