Business Liabilities Every Owner Should Know

• Liabilities are debts or other obligations in which your business owes money, now or in the future.
• Assets are items of value that your business owns, such as real estate and equipment.
• Assets and liabilities are part of a business’s balance sheet and are used to judge the business’s financial health.
• This article is for small business owners who want to learn what liabilities are and see examples of common business liabilities.

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.

What are small business liabilities and assets?

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.

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What are liabilities?

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:

• Current liabilities: These need to be paid back within a year and include credit lines, loans, salaries and accounts payable.
• Long-term liabilities: These take more than a year to repay and include loans such as mortgages or bonds.
• Contingent liabilities: These are liabilities that depend on the outcome of a future event, such as a lawsuit.

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: 

• Accounts payable
• Interest payable
• Income taxes payable
• Bills payable
• Short-term business loans
• Bank account overdrafts
• Accrued expenses

Current liabilities can be used as a key component to judge how your business is doing financially using the following key ratios:

• Current ratio: Current assets divided by current liabilities
• Quick ratio: Current assets minus inventory divided by current liabilities
• Cash ratio: Cash and cash equivalents divided by current liabilities

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.

What are assets?

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.

• Current assets: These are assets that can be converted into cash, such as accounts receivable and inventory.
• Fixed assets: These are physical items that your business expects to own for more than a year and has financial value to your company, such as tools, vehicles or computer equipment.

The difference between an expense and a liability

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.

How do business liabilities work?

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]

Examples of business liabilities

There are many types of business liabilities, both current and noncurrent. The following are some of the most common types.

Current liabilities

• Wages payable: This is the total amount of accrued income employees have earned but not yet received. This liability changes often, because most employees are paid every two weeks. 
• Interest payable: If your company uses credit to purchase goods and services, this liability represents the interest on short-term credit purchases to be paid. 
• Dividends payable: If your business has issued stock to investors and pays dividends on those stocks, this current liability represents the amount owed to shareholders after the dividend was declared.

Noncurrent liabilities

• Deferred credits: These items may be recorded as current or noncurrent liabilities depending on the transaction, and are revenue collected prior to it being earned and recorded on an income statement. 
• Post-employment benefits: If one of your employees retires, these are the benefits they or a family member may receive. The benefit is carried as a long-term liability as it accrues. 
• Unamortized investment tax credits: This liability represents the net between an asset’s historical cost and the amount that has already been depreciated. 
• Warranty liability: This is an estimated amount of time and money that may be spent repairing a product under the term of its warranty.

[Related Content: Accrual vs Cash Accounting Methods]

Examples of assets

• Cash: Cash is the most common business asset, as it can be spent at a moment’s notice. Cash assets can range from a few dollars to the nearly $200 billion that Apple Inc. had at its disposal in June 2020 (and sales have increased 36% since then).
• Securities: Securities are types of assets that can be quickly and easily liquidated to increase cash on demand, such as equity. Securities can also include stocks, bonds and nonpublic assets that are similar in function.
• Inventory: Your inventory is your cache of physical goods on shelves or in warehouses that can be sold for money. Typically, inventory is liquidated by selling to customers or to similar businesses.
• Property: This refers to lots, land and buildings that your business may own, such as an office, a storefront or undeveloped land. Property is most commonly liquidated through direct sale or an equity loan. The latter enables a business to get cash for its property without relinquishing ownership.
• Equipment: Pieces of equipment that hold significant value after purchase are considered business assets. This can include motor vehicles, high-performance multifunction copiers, computer servers, and anything else the business uses and could potentially sell for substantial cash.
• Intellectual property: Also called IP, this is any asset classified as intangible. The value of IP can be difficult to determine, but through licensing contracts, IP can generate revenue that you can use to calculate a fixed value for the IP as a whole.
• Brand: Brand is another intangible asset that can be difficult to value precisely. A brand’s value is usually tied to its recognizability and reputation. Mercedes is a good example of a brand that is easily recognized and associated with high quality.

How accounting software can help track assets and liabilities

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:

• Wave Financial: Wave is a great option for solopreneurs, freelancers and small businesses. It’s free accounting software that links to your bank account so you can easily track new business expenses. However, its integrations are more limited than some of its competitors’ selections.
  
  
• QuickBooks: QuickBooks is an affordable option for businesses of all sizes. It comes with a variety of features, like invoicing, tracking expenses and managing payroll. The company also offers dozens of articles and video tutorials to make the software easier to navigate. [Read related article: Which Version of QuickBooks Online Should You Use?]
  
  
• FreshBooks: FreshBooks is ideal for anyone who needs to regularly send and accept payments via invoices. The invoice generator makes it easy to create professional invoices quickly, and you can set up automated payment reminders for clients.
  
  
• Xero: Xero is a viable option for your growing company. The software integrates with over 700 apps, and you’ll have access to 24-hour customer support. You can also use the software to create financial reports, like profit and loss statements. Read our review of Xero to see why it’s good for scaling companies.

Source: Accounting Coach

Kiely Kuligowski contributed to the writing and research in this article.