A contingent liability is a potential loss that may or may not occur in the future. What is a liability? Liability is an event where one party is obligated to pay another party depending on some contract.
This liability has three parts – Non-Current liability, current liability, and contingent liability. The events of the future determine whether a contingent liability will convert into a liability.
Example
Suppose an employee of a company files a case against that company for Rs 20,000 on some discrimination charges. This Rs 20,000 becomes a contingent liability for the company. If this allegation is proved correct, it converts into a liability. If the allegation is proven wrong, then that contingent liability will be removed.
Other examples of contingent liabilities are warranties and lawsuits.
How does it affect investors?
Investors like you and I get more information when a company reports a contingent liability in its financial statements. When a company recognises its potential losses, it can make provisions beforehand. These provisions indicate the increase/decrease in profitability of the company for the next quarter/year. This gives investors an idea of the revenue and net profits of the company for the next term.