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 to 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.
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 warranty and lawsuits.
How does it affects investors?
Investors like you and me get more information when a company reports a contingent liability in their financial statements. When a company recognises their potential losses, they can make provisions beforehand. These provisions indicate the increase/decrease in profitability of the company for next quarter/year. This gives investors an idea of revenue and net profits of the company for the next term.