As a business owner, it’s likely that you already have some liabilities related to your company. A liability is anything that results in debt or is a potential risk, and it is used in key ratios to determine your organization’s financial health.
Read on to learn what liabilities, assets and expenses are, and how they differ from each other. You’ll also understand common liabilities for small businesses.
In the accounting world, assets, liabilities and equity make up the three major categories of your business’s business balance sheet. Assets and liabilities are used to evaluate your business’s financial standing, and to show its equity by subtracting your company’s liabilities from its assets. For these reasons, it’s important to have a good understanding of what business liabilities are and how they work.
Liabilities, assets and equity are used to evaluate a business’s financial health.
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Liabilities include everything your business owes, presently and in the future. These include loans, legal debts or other obligations that arise in the course of business operations. The loans are often used to finance your operations, or pay for expansions or new equipment.
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 will generally want to monitor current liabilities, also known as short-term liabilities, closely to ensure you have enough liquidity – or the ability to cover immediate and short-term obligations – for your outstanding debts.
These are some examples of current liabilities:
Current liabilities can be used as a key component to judge how your business is doing financially using the following key ratios:
Noncurrent liabilities, also known as long-term liabilities, are due after more than a year. Your company would 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.
Long-term liabilities are vital for determining your business’s long-term 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 risk – only affect the company depending on the outcome of a specific future event. For example, if a company is facing a lawsuit, they face 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.
Assets are everything a business owns, and these are typically found on the left side of a balance sheet. There are two types of assets: current and fixed.
An expense is the cost of operations that a company incurs to generate revenue. The major difference between expenses and liabilities is that an expense is related to your 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.
|Cost of operating a business to generate revenue||Obligations and debt the business owes|
|Closely related to 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|
Liabilities are anything your business owes currently or in the future, and are classified as current or noncurrent. Assets are anything of value your business owns, and are current or fixed.
A simple way to understand business liabilities is to look at how you pay for anything for your business. You either pay with cash from a checking account or borrow money. All borrowing creates a liability, including using a credit card.
All of your liabilities will be shown on your balance sheet, which is a financial statement that reveals how your business is doing at the end of an accounting period. Liabilities can be settled over time through the transfer of money, goods or services.
To calculate your total liabilities, you list all of your liabilities and add them together. You can also use a basic accounting formula to find out if your books are balanced. To do this, calculate liabilities + equity = assets. To be balanced, your total liabilities plus your total equity must equal 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, this will equal your total assets.
There are many types of business liabilities, both current and noncurrent. The following are some of the most common types.
[Related Content: Accrual vs Cash Accounting Methods]
There are many types of current and noncurrent liabilities that most small businesses encounter over time.
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:
Kiely Kuligowski contributed to the writing and research in this article.