Earlier today, our good friend David posed a question of liabilities. I believe his exact words were: hey, that's strange. Why would wikipedia spend three paragraphs describing liabilities when it simply means the same as debt?


Well David, that's a good question.

Let's take a walk down wall street and see if we can find someone to help us find the answer to this difficult question.

Hmm...

Oh look! Let's ask that young gentleman there. Sir, may we bother you for a moment?


Splendid!

You see, my friend David would like to know why liabilities are called so, instead of simply debt. Would you mind clearing this up for us?



Ah, I see.

If we look at this gentleman's dance, we can interpret meaning from it. You see, liabilities is business jargon. Although all debt is debt in the end, business cannot exist without taking on some risk. Usually, that risk manifests itself in different interest rates. The larger the risk, the higher the interest rate and premium. Ah. Our vibrant friend would like us to meet the finance department of his establishment. Ah, the business world is one full of magic and unexpected treasure. Whatever could he have in store for us Lead the way, gentle businessman!


Well hello there, gentlemen! Another lively bunch, I see.


If we watch their movements, maybe we can discern what they're saying!

It would appear that these men have unlocked the secret we have been trying to reveal to liabilities. You see, when you go to investors for money, they want to know when they're going to get their money back, and they want to know how you borrowing money from others will effect their overall return. Therefore, money borrowed is divided into two groups: short term liabilities and long term liabilities. Short term liabilities usually carry larger interest over a long period of time. Why? Because the likeliness of keeping a pay schedule for tens of thousands of dollars paid by the end of six months is laughable. Think of it as if you would max out your credit card. The harder time you have paying minimum balances, the higher the risk and the higher the interest charged.



So what do companies do to protect themselves from higher interest rates? They take out long term liabilities. That is, debt that will take more than a year to pay off. Since the payments are lower, the risk is usually low as well. Likewise, investors like some long term pay offs in their portfolio to ensure there will always be a cashflow.

Wow David, we sure did learn a lot today.



Post has been edited 1 time(s), last time on Jan 30 2011, 5:05 am by Fire_Kame.