4.2 Liabilities and expenditure
As you saw in Section 2.1, debts are liabilities: a stock of money owed at a certain point in time. Such liabilities include long-term debt, such as a mortgage, as well as short-term debts such as an overdraft. I want to explain the interrelationship between such liabilities and expenditure. This is illustrated in Figure 9.
Figure 9 shows that liabilities and expenditure are inextricably linked. For example, taking on a liability will generate a future flow of expenditure in the form of debt repayments (both of the principal and, crucially, of the interest). It’s important to realise that having liabilities will give rise to higher future expenditure.
Similarly, higher levels of expenditure can give rise to liabilities. If, for instance, a household’s expenditure exceeds its income (and has no savings to draw on), then in order to fund that expenditure, a liability will arise. For example, people might run up a credit card bill, or have to increase their overdraft. Conversely, repayments of debt would gradually reduce the stock of liability over time if the repayments are of sufficient size to cover all the interest and to repay some of the capital.
To illustrate, someone may want to borrow £10,000 to buy a car. This stock of debt will be a liability; it will also give rise to monthly repayments which will be part of that person’s expenditure.
Can you think of any situations where taking out a debt to fund a purchase can also lead to the acquisition of an asset?
The most common answer to this question would be a home, where the house’s market value would be an asset and the amount of mortgage outstanding will be a liability. There are other possible examples – ranging from jewellery or collectibles to financial assets such as stocks and shares.