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As a business owner, it’s likely that you already have some liabilities related to your company. Any debt that your business owes or amount it’s expected to pay is a liability. While liabilities are usually fiscal, the term could also refer to any other type of obligation that your business has. Liabilities are used in key ratios that help determine your organization’s financial health.
Read on to learn the definitions of liabilities, assets and expenses, as well as some common liabilities for small businesses.
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In the accounting world, assets, liabilities and equity make up the three major categories of your business balance sheet, which is a financial statement that reveals how your business is doing at the end of an accounting period. To evaluate your business’s financial standing, you have to know its assets – what you own – and liabilities – what you owe. You can find your business’s equity by subtracting liabilities from assets. To make sure your business is on the right track, you should keep an eye on liabilities and assets.
Depending on your business’s size and financial circumstances, you may revisit your balance sheet on a monthly, quarterly or annual basis. Updating your balance sheet often could help you keep your business organized.
Liabilities include your business’s current debts, as well as the amounts it will be responsible for in the future. Loans, legal debts and obligations that arise from normal business operations are all liabilities.
Liabilities can typically be found on the right side of a balance sheet. Most businesses have liabilities, unless they only accept cash payments and also pay with cash. There are three main types of liabilities:
You should generally monitor current liabilities (also known as short-term liabilities) closely to ensure you have enough liquidity for your outstanding debts.
These are some examples of current liabilities:
Current liabilities play a key role in the following ratios, which offer insight into your company’s financial well-being:
Noncurrent liabilities, also known as long-term liabilities, take more than a year to repay completely. Your company may take on a long-term liability to acquire immediate capital to purchase an office building or computer equipment, for example, or to invest in new capital projects.
Understanding long-term liabilities is vital for determining your business’s solvency, or ability to meet long-term financial obligations. Your organization would fall into a solvency crisis if you are unable to pay the long-term liabilities when they are due.
Contingent liabilities – or potential risks – may or may not affect the company. They depend on the outcome of a specific future event. For example, if a company is facing a lawsuit, it faces a liability if the lawsuit is successful, but not if the lawsuit fails. For accounting purposes, a contingent liability is only recorded if a liability is probable and if the amount can be reasonably estimated.
An expense is an operational cost that a company incurs to generate revenue. Unlike liabilities, expenses are directly tied to a firm’s revenue. Expenses and revenue are listed on an income statement, but not on a balance sheet with assets and liabilities.
Expenses can also be paid immediately with cash, while delaying payment would make the expense a liability.
Expenses | Liabilities |
---|---|
Cost of operating a business | Obligations and debt the business owes |
Directly helps generate a company’s revenue | Something the business owes now or in the future |
Listed on a company’s income statement | Listed on a company’s balance sheet |
Business expenses may be fixed, which means they typically stay the same over time, or variable (often changing). Fixed expenses include rent and payroll, while variable expenses include utilities and commissions.
A simple way to understand business liabilities is to look at how you pay for business expenses: You either use cash from a checking account or borrow money. Every time you borrow money – by taking out a loan or using a credit card – you create a liability. You could settle a liability through cash, products or the exchange of services. However, the most common method is simply by repaying a loan over time.
To calculate your business’s total liability, add all individual liabilities together. You can also use a basic accounting formula to find out if your books are balanced: liabilities + equity = assets. When your books are balanced, your total liabilities plus your total equity equals the number of total assets. [Read related article: Accounting Ratios and Formulas: The Basics You Need to Know]
Business liabilities are accrued when you borrow money to pay for anything for your business and must be settled over time. To find out if your books are balanced, add your liabilities and your equity. If your books are balanced, the sum will equal your total assets.
You may encounter many current and noncurrent liabilities as you operate any business. The following are some of the most common types.
[Related content: Cash vs. Accrual Accounting Methods]
Anything valuable that a company owns is a business asset. Assets are typically found on the left side of a balance sheet. There are two types of assets: current and fixed.
The best accounting software can help you track your business’s assets, expenses and liabilities. The information you track will help you manage your cash flow and evaluate the financial health of your company.
The right accounting software depends on the size of your business and your invoicing needs. Here are some of our best picks:
Almost all businesses operate with some liabilities – before you can make money, you often have to borrow some money. However, if your debt builds more quickly than you anticipated, you should take some steps to protect your business. You may be able to renegotiate your terms with your lender in order to reduce your payments, for example. Consider the assets that you may be able to liquidate quickly without hurting your operations.
If you need some help, you might want to bring in an accounting or business advisor to help you get back on track. Understanding the role liabilities play in your business’s overall financial health is central to its stability and growth.
Cailin Potami and Kiely Kuligowski contributed to this article.