Contingent liabilities are examples of financial obligations that a company is anticipated to pay, even though the level of probability may vary from anywhere from minimal to relative assurance that the obligation will be met. Calculating the exact rate of probability connected to any given contingent liability will take into consideration a number of factors, including events that are expected to take place in the near future.
The classic example of a contingent liability is an outstanding lawsuit that has been properly filed against the corporation. Until the lawsuit is resolved, there is not a solid figure of liability that can be attached to the action. However, it is possible to project what the outcome of the lawsuit will be, and the amount of obligation the corporation will eventually be ordered to pay. From this perspective, it is possible to determine the contingent liability in the worst case scenario, and then use this figure to assess the ability of the company to honor the debt and dispose of it in a timely manner.
However, the formula for calculating contingent liability does not necessarily have to be connected with anticipating the end effects of a lawsuit. The same approach can be applied to launching a new operating division of a company, or even a new product. In these types of applications, the company would assess the financial obligation that would take place in producing and issuing the new product at various rates of production. The contingent liability could be the amount due to vendors for the raw materials needed to manufacture the product as compared to the company’s current ability to pay for those additional raw materials.
The main function of calculating a contingent liability is to arrive at a realistic expectation of the corporation’s ability to settle the obligation in full. In situations where the contingent liability appears to be minimal, vendors may choose to refuse orders for additional materials, or courts may order that assets of the corporation be seized and liquidated in order to settle any amount awarded in a lawsuit.