Total liabilities

A household owns things. It also owes things. Total liabilities is the second half of that picture.

Total liabilities add up every loan the household has taken. A home loan counts. A car loan counts. So do a personal loan and credit card dues.

Some of this money is owed to a bank. Some may be owed to a friend or a relative. The workbook treats both the same way. Money owed is money owed, whoever lent it.

On its own, this one number does not say whether a household is in trouble. It has to be read against assets and against income. But it is the number every other personal finance ratio in this chapter starts from.

The workbook splits liabilities two ways. By who lent the money: institutional sources such as banks and financial institutions, or personal sources such as friends and relatives. By structure: long-term and secured on an asset, such as a mortgage for a house or a car loan, or short-term and unsecured, such as credit card outstanding and personal loans — and the workbook notes that unsecured, short-term liabilities tend to be more expensive.

The workbook's own running example adds three such liabilities for one investor: an outstanding home loan of Rs 10 lakh, credit card dues of Rs 2 lakh, and a Rs 1 lakh loan from a friend. Total liabilities = 10 + 2 + 1 = Rs 13 lakh. That single figure then feeds three further calculations on the same investor: the leverage ratio (liabilities ÷ assets = 20%), the solvency ratio (net worth ÷ assets = 80%) and net worth itself (assets minus liabilities = Rs 52 lakh).

A liability creates an obligation to repay out of future income, so the workbook's rule is to use debt with caution, ideally only to acquire an asset that will appreciate in value.

Illustrative household, using the workbook's own categories.

The Rao family lists what they owe:

Sorting the list this way shows two things. First, Rs 3,00,000 of it — the personal loan, the card dues and the cousin's loan — is short-term and unsecured, exactly the category the workbook flags as the most expensive to carry. Second, the secured, long-term loans paid for assets the family expects to keep and that can appreciate; the unsecured portion funded no asset at all.

An adviser reading this list targets the Rs 3,00,000 first, not the home loan, because that is where the interest cost is highest and where the family gets least in return for the debt.

Chapter 3 (Cash Flow Management and Budgeting), section 3.9.3 (Total Liabilities), right after Total Assets at 3.9.2 and right before the Leverage Ratio at 3.9.4, which uses total liabilities as its numerator. Expect a question that lists several loans and dues and asks for the total, or one that asks which category of liability tends to cost more.

• A liability is not just a bank loan. Credit card dues and a loan from a friend or relative both count, however small.
• Unsecured, short-term liabilities cost more, not less, than secured long-term ones — a common reversal among the exam's answer options.
• Total liabilities is not net worth. Net worth is total assets minus total liabilities; total liabilities alone is only one side of the sum.
• The outstanding balance is used, not the original loan amount — the same convention the leverage ratio applies to this same figure.