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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What are small business liabilities and assets?
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 circ*mstances, 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.
What are liabilities?
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:
- Current liabilities: Debts that need to be repaid within a year, like credit lines, loans, salaries and accounts payable
- Non-current liabilities: Loans that usually take more than a year to repay, like mortgages or bonds
- Contingent liabilities: These are liabilities that depend on the outcome of a future event, like settlements from a lawsuit
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:
- Accounts payable
- Interest payable
- Income taxes payable
- Bills payable
- Short-term business loans
- Bank account overdrafts
- Accrued expenses
Current liabilities play a key role in the following ratios, which offer insight into your company’s financial well-being:
- 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, 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.
The difference between an expense and a liability
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 |
Did You Know?
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.
How do business liabilities work?
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]
Key Takeaway
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.
Common business liabilities
You may encounter many current and noncurrent liabilities as you operate any business. 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 many employees are paid weekly, biweekly or monthly.
- Interest payable: If your company uses credit, your outstanding balance may accrue interest to be repaid in the short term.
- Dividends payable: This is the amount you may owe shareholders If your business has issued stock and pays dividends on those stocks.
Noncurrent liabilities
- Deferred credits: This is revenue collected prior to it being earned and recorded on an income statement. These items may be recorded as current or noncurrent liabilities depending on the transaction.
- Post-employment benefits: These are the benefits your employee or their family may receive if they retire. 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 it may take to repair an object, according to the terms of its warranty.
[Related content: What’s the Difference Between Cash Basis and Accrual Basis?]
What are assets?
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.
- Current assets: These are assets that your business plans on converting to cash in the immediate future, such as accounts receivable and inventory.
- Fixed assets: These are physical items that your business expects to maintain and use for more than a year. Fixed assets, such as tools, vehicles and computer equipment, are resources that bring value to your company.
Examples of assets
- Cash: Cash is the most basic business asset, as it can be spent at a moment’s notice. Cash assets can range from a few dollars to billions.
- 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 you intend to sell. Companies typically liquidate inventory in their normal operations by selling it to customers or to similar businesses.
- Physical 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 a type of intangible asset related to original ideas or creations, like a patent. 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: Technically, a brand refers to the name of a product or service. Major brands may also have unique visual or written identities that distinguish them from others, which sometimes provide a certain level of trust with consumers. In that sense, a brand is another type of intangible asset that can be difficult to value precisely since its 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.
The best accounting software to 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. Our review of Wave Financial offers a more in-depth look at its strengths and shortcomings.
- 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 more in our full QuickBooks review. [Read related article: Which Version of QuickBooks 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. To learn more about why it works well for invoice management, read our review of FreshBooks.
- 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 discover more.
Managing business liabilities
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.
