Stockholder's equity and liabilities are both monies that a firm owes. They are not, however, the same thing, and it is important for managers and shareholders to understand why this is the case. They should understand what stockholder's equity and liabilities are, how they are similar and in what ways they are different.
Definition of a Liability
A liability is any financial obligation that a firm is required to meet. In simple terms, a liability is money that a company owes to external parties; that it is to say that it is debt that the company holds. Examples of liabilities include outstanding loans, salaries payable, taxes owed and accounts payable.
When a corporation has profits, it can either reinvest them or it can distribute them to shareholders. if the company plans to distribute them to shareholders, then the funds are retained as stockholder's equity until the amount is paid to the shareholders as a dividend. In essence, stockholder's equity is the profit that a corporation owes to its owners.
Stockholder's equity is similar to a liability in that it is an amount of money that is earmarked to be paid out (to shareholders and creditors, respectively). On a balance sheet, stockholder's equity and liabilities are placed in the right hand column while assets are placed in the left hand column. The total of a firm's liabilities and stockholder equity must always be equal to its assets.
Although a stockholder's equity has similarities to a liability, it is not considered to be a liability itself. The important difference between stockholder's equity and liabilities is that stockholder equity is money owed to shareholders within the company while liabilities are owed to external parties. It is also important to note that in bankruptcy law, liabilities take precedence over stockholders' equity, meaning that a firm must pay its debts before its shareholders in the event of a bankruptcy.
- "Financial Accounting: An Introduction to Concepts, Methods and Uses"; Clyde P. Stickney, et al.; 2009
- CliffNotes: The Balance Sheet -- Stockholders' Equity
- Encyclopedia Britannica: Balance Sheet