What is liabilities? For some reason it is a very difficult question to answer when most people are either completely unaware or simply cannot seem to find the correct answer. The fact is that in any entity, at any given time, there is always a potential for liabilities to exist. Liabilities can be actual or potential. Some examples include, claims of the corporation against another entity for breach of contract; debts owed by one entity to another for breach of agreement; and finally claims made against an individual by another entity for breach of fiduciary duties. Any one of these situations can exist and in fact have already occurred.
Therefore, for any entity, no matter what its physical assets may consist of, there always exists the potential for loss. This potential loss can be either temporary or permanent. In general terms, a temporary loss is one caused by a past event that has altered the course of events that would have resulted in a beneficial result had the event not occurred. A permanent loss is the result of inability of a person or entity to achieve a desired result due to past or future events that have occurred.
So, what are liabilities? Essentially, liabilities are an event that causes a loss or sacrifice. When an entity suffers a loss, then that entity is considered to have incurred a liability. The degree of severity of the liability is usually tied to the amount of loss. For instance, if an entity suffers a loss due to theft from the business, then that loss will be classified as being a direct liability and the entity may be held personally liable for the entire loss.
Let’s now apply this same reasoning to assets. If we take a vehicle, car, boat, etc., and lose our car, what is the value of the asset? It will generally be a depreciated value. If we do not gain control of the car in a reasonable amount of time, meaning, if the car does not immediately depreciate in value, then it will likely be very difficult to sell the asset at a fair price in order to realize a gain. This is why it is so important to protect assets in order to realize a future economic benefit.
Now consider a scenario where you purchase a small business from a private owner. You agree to purchase the asset for an agreed upon price in order to gain control of a company. The private owner has decided that it is in his best interest to shut down the business so that he can take advantage of the sale of your asset to realize a future economic benefit by keeping the business open.
In this example, you have purchased the asset, but you have not gained control of the company. Therefore, you are still personally liable for the entire loss of the business. Further, even if you gained control of the company, you are responsible for the entirety of the debt of the business. This means that unless you pay off the entire debt of the business, you will lose your asset and incur future economic loss.
On the other hand, suppose that you were injured in an accident that was caused by another person or company. If the injured person sues you for damages, you may be held personally liable for all of the injuries that you sustained. This could include medical expenses that you may have incurred as a result of being injured. Therefore, liability insurance is probably a critical component of any business’s inventory insurance policy. It would make perfect sense to purchase the most appropriate liability insurance possible in order to protect your assets in the event of a lawsuit.
Again, we are simplifying the issue here. There are two distinct types of liabilities. There are primary liabilities, which include what is called primary debt. This is simply the debt owed to a company by another party. Liabilities include things such as accounts payable, property liens, and so on. The second type of liability is what is referred to as secondary liability; this refers to the legal obligation of a business to other parties.