What Are Liabilities in Accounting?
Liabilities in accounting are the financial obligations of a company, such as money owed to suppliers, wages owed to staff, and outstanding loans. Accountants record this information in the balance sheet.
What Are Liabilities in Accounting?
The definition for liabilities in accounting refers to a company’s financial responsibilities. For small businesses, this includes things such as accounts payable and money owed to suppliers. The details of these obligations are presented on the balance sheet, a typical financial statement. These costs are referred to as “payables.”
Every business has some form of liabilities, except companies that operate through a cash-only system. Operating with cash means that you pay and take payments with it, whether it be with physical cash or through a company checking account.
Please note that liabilities are not the same thing as expenses, even though they sound similar. An expense is the money a company spends to operate and generate revenue. Expenses are different from assets and liabilities in that they are related to income. The short version is that expenses are used in calculating net income. Total net income is business revenues minus expenses.
Let’s say that a company has more expenses than it does revenues over the past three years. In this situation, the business has poor financial stability as it has been losing money for three years.
It would be best not to confuse liabilities and expenses. Expenses are listed on the income statement, while liabilities go on the balance sheet. Expenses are how much money a business spends on operating costs, while liabilities refer to the financial obligations a company has. You can pay expenses immediately using cash. An expense can become a liability if it isn’t paid off in time.
You gain a liability every time you borrow rather than pay outright. Borrowing includes paying with a credit card unless you pay back the money within the month. A business loan or business mortgage also counts as a liability.
Here are some other examples of liabilities for small businesses:
- A social media marketer is required by state law to collect sales taxes on invoices issued to clients. The money stays in the bank account until needed. The balance of the account still counts as a liability as the money is sent back to the state at the end of each month to pay off taxes.
- A carpenter orders new doors from their supplier. They have a good relationship with the supplier, so they get the purchase on credit. The carpenter receives an invoice that they have to pay within 30 days. This amount is considered a liability for the carpenter who must pay it back.
- A business owner hires ten employees. They pay biweekly. Monday arrives, and they have to pay those wages by Thursday. The money owed to staff is a liability on their records.
- A writer uses their business credit card to get a new laptop. The laptop costs $2,000. They plan to pay the money back over the next few months. Until then, the remaining balance counts as a liability.
- An online seller decides to open a physical store. They take out a mortgage of $400,000 to purchase a commercial space for the store. The mortgage is a liability because this is a debt they must repay.
Liabilities are essential for small businesses. Owning money isn’t necessarily a bad thing. You occasionally need a loan to purchase assets, such as vehicles and tools, that you need to run and grow your business.
Too many financial liabilities do a lot of financial damage to small businesses. Owners should always keep track of how much they owe compared to how much they make with the debt-to-equity ratio and the debt-to-asset ratio. Your business should have enough assets to pay off debts and prevent financial problems.
What Are the Types of Liabilities?
Liabilities fall under two main categories: short-term liabilities and long-term liabilities. Both of these are filed on the balance sheet. The balance sheet is a financial report highlighting a business’s financial health at the end of the reporting period.
- Long-Term Liabilities
Long-term liabilities are the liabilities that will take over a year to pay back. This includes business loans and mortgages.
- Short-Term Liabilities
Short-term liabilities are the financial liabilities you can pay back within a year. This includes:
- Sales tax, typically paid monthly or quarterly
- Payroll taxes: income tax and employment tax is taken out of employee paychecks and sent to the government
- Loans and mortgages with monthly repayments
What Are the Categories of Liabilities?
Liabilities are divided into different categories on the balance sheet. The standard balance sheet is divided into seven different categories. These categories cover assets, equity, and liabilities. There are two categories dedicated to liabilities in particular:
- Current Liabilities
Current liabilities are also the short-term liabilities your business owes. These are the liabilities you can pay back within the year. This includes things such as client deposits, employee wages and salary, interest payable on loans, and money owed to suppliers.
- Long-Term Liabilities
Long-term liabilities are financial obligations that may take more than a year to pay back. Long-term liabilities are things such as business loans and mortgages. This list also includes deferred short-term liabilities.
Please don’t worry if you encounter something that looks like both a short-and-long-term liability. There are several things that can be classified as both, such as a loan you pay back over two years. The money you owe in the first year is a “current liability” while the rest of the balance owed is a “long-term liability.”
What Are Liabilities on a Balance Sheet?
Liabilities are one of the three categories recorded on the balance sheet, which is a financial report companies generate using accounting software. These balance sheets offer a look at the financial health of the business.
The balance sheet includes records of assets, equities, and liabilities.
Assets refer to anything that the company owns with some financial value, including the revenue (recorded as accounts receivable), equipment, and landholdings. The assets go on the left side of the balance sheet. Equity and liabilities go on the right.
As mentioned before, the liabilities are divided into short-and-long-term liabilities. Each liability is also listed under a category according to what it is. Accounts payable, for example, goes under short-term liabilities.
Below is an example of how liabilities look on a balance sheet:
Liabilities are an essential part of accounting. These costs allow businesses to grow and expand. Liabilities come in different forms but are not the same thing as expenses. Expenses are operating costs, while liabilities are financial obligations owed to others, such as wages and loan payments. Liabilities are either short-term or long-term, depending on how long they take to pay back. Anything that takes over a year to pay back is considered a long-term liability. Otherwise, it is a short-term liability. Liabilities are listed on the balance sheet according to their category.